Cosmo Lady (China) Holdings (HKG:2298) Is Finding It Tricky To Allocate Its Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. On that note, looking into Cosmo Lady (China) Holdings (HKG:2298), we weren't too upbeat about how things were going.

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. The formula for this calculation on Cosmo Lady (China) Holdings is:

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

0.032 = CN¥75m ÷ (CN¥3.8b - CN¥1.5b) (Based on the trailing twelve months to December 2023).

So, Cosmo Lady (China) Holdings has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Luxury industry average of 11%.

Check out 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 analyst report for Cosmo Lady (China) Holdings .

The Trend Of ROCE

We are a bit anxious about the trends of ROCE at Cosmo Lady (China) Holdings. The company used to generate 11% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 43% 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 39%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.2%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line

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 83% 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.