Prosperous Industrial (Holdings)'s (HKG:1731) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Although, when we looked at Prosperous Industrial (Holdings) (HKG:1731), it didn't seem to tick all of these boxes.

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)

0.039 = US$5.7m ÷ (US$185m - US$40m) (Based on the trailing twelve months to June 2022).

Therefore, Prosperous Industrial (Holdings) has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 11%.

Check out 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'd like to look at how Prosperous Industrial (Holdings) 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

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 3.9% from 20% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Prosperous Industrial (Holdings) has decreased its current liabilities to 21% 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. 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

In summary, despite lower returns in the short term, we're encouraged to see that Prosperous Industrial (Holdings) is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 99% over the last three years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we found 4 warning signs for Prosperous Industrial (Holdings) (1 can't be ignored) you should be aware of.

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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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.