Returns On Capital Signal Tricky Times Ahead For Smart Globe Holdings (HKG:1481)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at Smart Globe Holdings (HKG:1481), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Smart Globe Holdings is:

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

0.19 = HK$26m ÷ (HK$174m - HK$38m) (Based on the trailing twelve months to June 2021).

Therefore, Smart Globe Holdings has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Commercial Services industry average of 9.0% it's much better.

View our latest analysis for Smart Globe Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Smart Globe Holdings' ROCE against it's prior returns. If you're interested in investigating Smart Globe Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Smart Globe Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 42%, but since then they've fallen to 19%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Smart Globe Holdings has decreased its current liabilities to 22% 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.

Our Take On Smart Globe Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Smart Globe Holdings is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 901% return over the last three years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing: We've identified 4 warning signs with Smart Globe Holdings (at least 1 which is significant) , and understanding these would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.