I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Perennial International Limited (HKG:725).
Purchasing Perennial International gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Therefore, looking at how efficiently Perennial International is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
What is Return on Capital Employed (ROCE)?
Choosing to invest in Perennial International comes at the cost of investing in another potentially favourable company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. We’ll look at Perennial International’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:
ROCE Calculation for 725
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = HK$12m ÷ (HK$716m – HK$109m) = 2.3%
The calculation above shows that 725’s earnings were 2.3% of capital employed. Comparing this to a healthy 15% benchmark shows Perennial International is currently unable to return a satisfactory amount to owners for the use of their capital, which isn’t good for investors who have forgone other potentially solid companies.
A deeper look
Although Perennial International is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. If you go back three years, you’ll find that 725’s ROCE has decreased from 4.0%. In this time, earnings have fallen from HK$20m to HK$12m and capital employed has increased due to an increase in total assets employed , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
ROCE for 725 investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and management ability. Perennial International’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for 725’s future growth? Take a look at our free research report of analyst consensus for 725’s outlook.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Perennial International’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.