Cosmo Lady (China) Holdings (HKG:2298) Could Be At Risk Of Shrinking As A Company

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. Having said that, after a brief look, Cosmo Lady (China) Holdings (HKG:2298) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Cosmo Lady (China) Holdings, this is the formula:

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

0.01 = CN¥23m ÷ (CN¥3.5b - CN¥1.2b) (Based on the trailing twelve months to June 2023).

Thus, Cosmo Lady (China) Holdings has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Luxury industry average of 11%.

See our latest analysis for Cosmo Lady (China) Holdings

Above you can see how the current ROCE for Cosmo Lady (China) Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

The trend of returns that Cosmo Lady (China) Holdings is generating are raising some concerns. To be more specific, today's ROCE was 11% five years ago but has since fallen to 1.0%. On top of that, the business is utilizing 44% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 34%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.0%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

What We Can Learn From Cosmo Lady (China) Holdings' ROCE

To see Cosmo Lady (China) Holdings reducing the capital employed in the business in tandem with diminishing returns, is concerning. This could explain why the stock has sunk a total of 90% in the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know about the risks facing Cosmo Lady (China) Holdings, we've discovered 1 warning sign that you should be aware of.

While Cosmo Lady (China) 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.