Capital Allocation Trends At REF Holdings (HKG:1631) Aren't Ideal

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into REF Holdings (HKG:1631), we weren't too upbeat about how things were going.

What Is 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. Analysts use this formula to calculate it for REF Holdings:

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

0.069 = HK$7.4m ÷ (HK$143m - HK$36m) (Based on the trailing twelve months to June 2024).

So, REF Holdings has an ROCE of 6.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.0%.

View our latest analysis for REF Holdings

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

The Trend Of ROCE

The trend of ROCE at REF Holdings is showing some signs of weakness. The company used to generate 17% on its capital five years ago but it has since fallen noticeably. What's equally concerning is that the amount of capital deployed in the business has shrunk by 56% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

Our Take On REF Holdings' ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Yet despite these poor fundamentals, the stock has gained a huge 105% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a separate note, we've found 2 warning signs for REF Holdings you'll probably want to know about.

While REF Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.