Investors Could Be Concerned With Lever Style's (HKG:1346) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Lever Style (HKG:1346) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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. Analysts use this formula to calculate it for Lever Style:

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

0.001 = US$37k ÷ (US$62m - US$27m) (Based on the trailing twelve months to December 2020).

Thus, Lever Style has an ROCE of 0.1%. Ultimately, that's a low return and it under-performs the Luxury industry average of 7.2%.

View our latest analysis for Lever Style

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

So How Is Lever Style's ROCE Trending?

When we looked at the ROCE trend at Lever Style, we didn't gain much confidence. Around four years ago the returns on capital were 25%, but since then they've fallen to 0.1%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Lever Style has done well to pay down its current liabilities to 43% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From Lever Style's ROCE

In summary, we're somewhat concerned by Lever Style's diminishing returns on increasing amounts of capital. Investors must expect better things on the horizon though because the stock has risen 2.8% in the last year. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Lever Style does come with some risks though, we found 5 warning signs in our investment analysis, and 2 of those are potentially serious...

While Lever Style 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. 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.
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