Should You Be Impressed By Prosperous Printing's (HKG:8385) Returns on Capital?

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 Prosperous Printing (HKG:8385), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Prosperous Printing:

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

0.01 = HK$3.5m ÷ (HK$549m - HK$202m) (Based on the trailing twelve months to September 2020).

Therefore, Prosperous Printing has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 9.9%.

See our latest analysis for Prosperous Printing

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'd like to look at how Prosperous Printing has performed in the past in other metrics, you can view 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 Prosperous Printing, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 1.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Prosperous Printing has done well to pay down its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

In summary, we're somewhat concerned by Prosperous Printing's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 55% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with Prosperous Printing (including 1 which is concerning) .

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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