Fountain Set (Holdings) (HKG:420) Has Some Difficulty Using Its Capital Effectively

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Fountain Set (Holdings) (HKG:420), the trends above didn't look too great.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Fountain Set (Holdings) is:

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

0.039 = HK$148m ÷ (HK$5.4b - HK$1.6b) (Based on the trailing twelve months to December 2020).

Therefore, Fountain Set (Holdings) has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Luxury industry average of 7.4%.

Check out our latest analysis for Fountain Set (Holdings)

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 want to delve into the historical earnings, revenue and cash flow of Fountain Set (Holdings), check out these free graphs here.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Fountain Set (Holdings). Unfortunately the returns on capital have diminished from the 5.4% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Fountain Set (Holdings) to turn into a multi-bagger.

The Bottom Line

In summary, it's unfortunate that Fountain Set (Holdings) is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 76% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One final note, you should learn about the 3 warning signs we've spotted with Fountain Set (Holdings) (including 1 which is concerning) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. 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.
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