What Do The Returns On Capital At Royal Deluxe Holdings (HKG:3789) Tell Us?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Royal Deluxe Holdings (HKG:3789), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Royal Deluxe Holdings:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.088 = HK$24m ÷ (HK$474m - HK$205m) (Based on the trailing twelve months to September 2020).

So, Royal Deluxe Holdings has an ROCE of 8.8%. In absolute terms, that's a low return but it's around the Construction industry average of 10%.

See our latest analysis for Royal Deluxe Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Royal Deluxe Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Royal Deluxe Holdings, check out these free graphs here.

What Does the ROCE Trend For Royal Deluxe Holdings Tell Us?

On the surface, the trend of ROCE at Royal Deluxe Holdings doesn't inspire confidence. Around five years ago the returns on capital were 48%, but since then they've fallen to 8.8%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Royal Deluxe Holdings has done well to pay down its current liabilities to 43% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

While returns have fallen for Royal Deluxe Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Despite these promising trends, the stock has collapsed 76% over the last three years, so there could be other factors hurting the company's prospects. Therefore, we'd suggest researching the stock further to uncover more about the business.

One final note, you should learn about the 5 warning signs we've spotted with Royal Deluxe Holdings (including 1 which can't be ignored) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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