Some Investors May Be Worried About Cirtek Holdings' (HKG:1433) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Cirtek Holdings (HKG:1433) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Cirtek Holdings is:

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

0.054 = HK$14m ÷ (HK$362m - HK$102m) (Based on the trailing twelve months to December 2020).

So, Cirtek Holdings has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Luxury industry average of 7.0%.

See our latest analysis for Cirtek Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cirtek Holdings' ROCE against it's prior returns. If you're interested in investigating Cirtek Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Cirtek Holdings doesn't inspire confidence. Over the last four years, returns on capital have decreased to 5.4% from 30% four years ago. 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, Cirtek Holdings has done well to pay down its current liabilities to 28% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Bottom Line On Cirtek Holdings' ROCE

In summary, we're somewhat concerned by Cirtek Holdings' diminishing returns on increasing amounts of capital. However the stock has delivered a 8.9% return to shareholders over the last year, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Cirtek Holdings does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.

While Cirtek Holdings 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. 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.
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