Here's What To Make Of Prosperous Industrial (Holdings)'s (HKG:1731) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at Prosperous Industrial (Holdings) (HKG:1731), it didn't seem to tick all of these boxes.

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. To calculate this metric for Prosperous Industrial (Holdings), this is the formula:

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

0.022 = US$3.4m ÷ (US$185m - US$34m) (Based on the trailing twelve months to June 2020).

So, Prosperous Industrial (Holdings) has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Luxury industry average of 9.2%.

Check out our latest analysis for Prosperous Industrial (Holdings)

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 want to delve into the historical earnings, revenue and cash flow of Prosperous Industrial (Holdings), check out these free graphs here.

What Does the ROCE Trend For Prosperous Industrial (Holdings) Tell Us?

On the surface, the trend of ROCE at Prosperous Industrial (Holdings) doesn't inspire confidence. Around four years ago the returns on capital were 17%, but since then they've fallen to 2.3%. However it looks like Prosperous Industrial (Holdings) might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Prosperous Industrial (Holdings) has decreased its current liabilities to 18% of total assets. So we could link some of this to the decrease in ROCE. 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.

What We Can Learn From Prosperous Industrial (Holdings)'s ROCE

To conclude, we've found that Prosperous Industrial (Holdings) is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 36% over the last year, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Prosperous Industrial (Holdings) (of which 1 is potentially serious!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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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