There Are Reasons To Feel Uneasy About Gemilang International's (HKG:6163) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Gemilang International (HKG:6163) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Gemilang International is:

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

0.092 = US$2.0m ÷ (US$44m - US$22m) (Based on the trailing twelve months to April 2022).

Thus, Gemilang International has an ROCE of 9.2%. On its own that's a low return, but compared to the average of 6.9% generated by the Machinery industry, it's much better.

See our latest analysis for Gemilang International

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Gemilang International's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 20% five years ago, while capital employed has grown 23%. That being said, Gemilang International raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Gemilang International might not have received a full period of earnings contribution from it.

On a separate but related note, it's important to know that Gemilang International has a current liabilities to total assets ratio of 50%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Gemilang International's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Gemilang International have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 69% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know about the risks facing Gemilang International, we've discovered 2 warning signs that you should be aware of.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.