SMC Electric (HKG:2381) Is Finding It Tricky To Allocate Its Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at SMC Electric (HKG:2381), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for SMC Electric, this is the formula:

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

0.13 = HK$17m ÷ (HK$183m - HK$54m) (Based on the trailing twelve months to December 2023).

Therefore, SMC Electric has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 11% generated by the Consumer Durables industry.

View our latest analysis for SMC Electric

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating SMC Electric's past further, check out this free graph covering SMC Electric's past earnings, revenue and cash flow.

What Does the ROCE Trend For SMC Electric Tell Us?

In terms of SMC Electric's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 33% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect SMC Electric to turn into a multi-bagger.

The Key Takeaway

In summary, it's unfortunate that SMC Electric is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 5.1% in the last three years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for SMC Electric (of which 1 doesn't sit too well with us!) that you should know about.

While SMC Electric 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com