Investors Could Be Concerned With Smart City Development Holdings' (HKG:8268) Returns On Capital

What underlying fundamental trends can indicate that a company might be in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Smart City Development Holdings (HKG:8268), so let's see why.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Smart City Development Holdings, this is the formula:

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

0.10 = HK$13m ÷ (HK$300m - HK$167m) (Based on the trailing twelve months to March 2022).

Therefore, Smart City Development Holdings has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 7.3% it's much better.

View our latest analysis for Smart City Development Holdings

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

The Trend Of ROCE

There is reason to be cautious about Smart City Development Holdings, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 53% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Smart City Development Holdings becoming one if things continue as they have.

On a separate but related note, it's important to know that Smart City Development Holdings has a current liabilities to total assets ratio of 56%, 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.

In Conclusion...

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 45% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to know some of the risks facing Smart City Development Holdings we've found 2 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.