Returns On Capital At Pacific Textiles Holdings (HKG:1382) Paint A Concerning Picture

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Pacific Textiles Holdings (HKG:1382) we aren't filled with optimism, but let's investigate further.

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

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 Pacific Textiles Holdings:

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

0.22 = HK$754m ÷ (HK$5.2b - HK$1.7b) (Based on the trailing twelve months to September 2020).

Therefore, Pacific Textiles Holdings has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 9.2% earned by companies in a similar industry.

View our latest analysis for Pacific Textiles Holdings

Above you can see how the current ROCE for Pacific Textiles Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Pacific Textiles Holdings' ROCE Trend?

In terms of Pacific Textiles Holdings' historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 32% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Pacific Textiles Holdings becoming one if things continue as they have.

In Conclusion...

In summary, it's unfortunate that Pacific Textiles Holdings is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 37% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing to note, we've identified 2 warning signs with Pacific Textiles Holdings and understanding these should be part of your investment process.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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