We're Watching These Trends At Honma Golf (HKG:6858)

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Honma Golf (HKG:6858) and its ROCE trend, we weren't exactly thrilled.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Honma Golf, this is the formula:

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

0.016 = JP¥384m ÷ (JP¥39b - JP¥15b) (Based on the trailing twelve months to March 2020).

Therefore, Honma Golf has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Leisure industry average of 7.7%.

Check out our latest analysis for Honma Golf

In the above chart we have measured Honma Golf's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Honma Golf.

What Can We Tell From Honma Golf's ROCE Trend?

When we looked at the ROCE trend at Honma Golf, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.6% from 34% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Honma Golf has decreased its current liabilities to 39% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Honma Golf's ROCE

In summary, we're somewhat concerned by Honma Golf's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 43% from where it was three years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Honma Golf does have some risks, we noticed 2 warning signs (and 1 which is concerning) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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