When researching a stock for investment, what can tell us that the company is in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Sinomax Group (HKG:1418), we weren't too hopeful.
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. The formula for this calculation on Sinomax Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.047 = HK$53m ÷ (HK$2.5b - HK$1.4b) (Based on the trailing twelve months to December 2020).
Thus, Sinomax Group has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 13%.
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 Sinomax Group 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
There is reason to be cautious about Sinomax Group, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 20% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Sinomax Group becoming one if things continue as they have.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 55%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 4.7%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Key Takeaway
In summary, it's unfortunate that Sinomax Group is generating lower returns from the same amount of capital. Unsurprisingly then, the stock has dived 81% over the last five years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing: We've identified 5 warning signs with Sinomax Group (at least 2 which are a bit unpleasant) , and understanding these would certainly be useful.
While Sinomax Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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