Cosmo Lady (China) Holdings' (HKG:2298) Returns On Capital Not Reflecting Well On The Business

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Cosmo Lady (China) Holdings (HKG:2298), we weren't too hopeful.

What Is 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. 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)

0.019 = CN¥41m ÷ (CN¥3.5b - CN¥1.3b) (Based on the trailing twelve months to December 2022).

Therefore, Cosmo Lady (China) Holdings has an ROCE of 1.9%. 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 report on analyst forecasts for the company.

What Does the ROCE Trend For Cosmo Lady (China) Holdings Tell Us?

We are a bit anxious about the trends of ROCE at Cosmo Lady (China) Holdings. To be more specific, today's ROCE was 12% five years ago but has since fallen to 1.9%. On top of that, the business is utilizing 39% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. 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 37%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.9%. 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.

The Bottom Line On 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. We expect this has contributed to the stock plummeting 91% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we've found 3 warning signs for Cosmo Lady (China) Holdings that we think you should be aware of.

While Cosmo Lady (China) 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.