Should We Be Excited About The Trends Of Returns At Narnia (Hong Kong) Group (HKG:8607)?

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Narnia (Hong Kong) Group (HKG:8607), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Narnia (Hong Kong) Group:

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

0.063 = CN¥12m ÷ (CN¥342m - CN¥148m) (Based on the trailing twelve months to September 2020).

Thus, Narnia (Hong Kong) Group has an ROCE of 6.3%. Ultimately, that's a low return and it under-performs the Luxury industry average of 9.2%.

See our latest analysis for Narnia (Hong Kong) Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Narnia (Hong Kong) Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Narnia (Hong Kong) Group, check out these free graphs here.

What Can We Tell From Narnia (Hong Kong) Group's ROCE Trend?

On the surface, the trend of ROCE at Narnia (Hong Kong) Group doesn't inspire confidence. Over the last three years, returns on capital have decreased to 6.3% from 28% three years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Narnia (Hong Kong) Group has decreased its current liabilities to 43% 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. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Narnia (Hong Kong) Group's ROCE

In summary, we're somewhat concerned by Narnia (Hong Kong) Group's diminishing returns on increasing amounts of capital. Investors must expect better things on the horizon though because the stock has risen 2.0% in the last year. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Narnia (Hong Kong) Group (including 2 which can't be ignored) .

While Narnia (Hong Kong) Group 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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