Prosperous Industrial (Holdings) (HKG:1731) Will Be Hoping To Turn Its Returns On Capital Around

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. However, after briefly looking over the numbers, we don't think Prosperous Industrial (Holdings) (HKG:1731) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. 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)

0.014 = US$2.1m ÷ (US$193m - US$40m) (Based on the trailing twelve months to December 2020).

So, Prosperous Industrial (Holdings) has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 6.9%.

View our latest analysis for Prosperous Industrial (Holdings)

Historical performance is a great place to start when researching a stock so above you can see the gauge for Prosperous Industrial (Holdings)'s ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Prosperous Industrial (Holdings), check out these free graphs here.

The Trend Of ROCE

When we looked at the ROCE trend at Prosperous Industrial (Holdings), we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.4% from 16% 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 21% of total assets. So we could link some of this to the decrease in ROCE. 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

In summary, we're somewhat concerned by Prosperous Industrial (Holdings)'s diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 544% over the last year, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing Prosperous Industrial (Holdings) we've found 2 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

While Prosperous Industrial (Holdings) 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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