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

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So while Lever Style (HKG:1346) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Return On Capital Employed (ROCE): What Is It?

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)

0.24 = US$9.7m ÷ (US$96m - US$55m) (Based on the trailing twelve months to June 2022).

Thus, Lever Style has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

View our latest analysis for Lever Style

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're interested in investigating Lever Style's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Lever Style's ROCE Trend?

When we looked at the ROCE trend at Lever Style, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 38% where it was five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Lever Style has decreased its current liabilities to 57% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 57% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Lever Style's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Lever Style is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 32% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know more about Lever Style, we've spotted 3 warning signs, and 1 of them shouldn't be ignored.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.