Prosperous Industrial (Holdings) (HKG:1731) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Prosperous Industrial (Holdings) (HKG:1731) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

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 Prosperous Industrial (Holdings):

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

0.011 = US$1.6m ÷ (US$180m - US$33m) (Based on the trailing twelve months to June 2021).

Thus, Prosperous Industrial (Holdings) has an ROCE of 1.1%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 7.0%.

View 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're interested in investigating Prosperous Industrial (Holdings)'s past further, check out this free graph of past earnings, revenue and cash flow.

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. Over the last five years, returns on capital have decreased to 1.1% from 17% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Prosperous Industrial (Holdings)'s ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Prosperous Industrial (Holdings) have fallen, meanwhile the business is employing more capital than it was five years ago. Despite the concerning underlying trends, the stock has actually gained 17% over the last three years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing: We've identified 2 warning signs with Prosperous Industrial (Holdings) (at least 1 which is concerning) , and understanding them would certainly be useful.

While Prosperous Industrial (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.