These Metrics Don't Make Carpenter Tan Holdings (HKG:837) Look Too Strong

When researching a stock for investment, what can tell us that the company is in decline? 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at Carpenter Tan Holdings (HKG:837), we've spotted some signs that it could be struggling, so let's investigate.

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 Carpenter Tan Holdings is:

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

0.14 = CN¥83m ÷ (CN¥659m - CN¥67m) (Based on the trailing twelve months to June 2020).

So, Carpenter Tan Holdings has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 9.2% it's much better.

View our latest analysis for Carpenter Tan Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Carpenter Tan Holdings' ROCE against it's prior returns. If you're interested in investigating Carpenter Tan Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Carpenter Tan Holdings' ROCE Trending?

There is reason to be cautious about Carpenter Tan Holdings, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 24% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Carpenter Tan Holdings becoming one if things continue as they have.

On a related note, Carpenter Tan Holdings has decreased its current liabilities to 10% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 73% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Carpenter Tan Holdings does have some risks, we noticed 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

While Carpenter Tan 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. 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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