Be Wary Of Tang Palace (China) Holdings (HKG:1181) And Its Returns On Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. Having said that, after a brief look, Tang Palace (China) Holdings (HKG:1181) we aren't filled with optimism, but let's investigate further.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Tang Palace (China) Holdings:

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

0.061 = CN¥24m ÷ (CN¥779m - CN¥387m) (Based on the trailing twelve months to June 2024).

Thus, Tang Palace (China) Holdings has an ROCE of 6.1%. On its own, that's a low figure but it's around the 7.0% average generated by the Hospitality industry.

Check out our latest analysis for Tang Palace (China) Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tang Palace (China) Holdings' ROCE against it's prior returns. If you'd like to look at how Tang Palace (China) Holdings has performed in the past in other metrics, you can view this free graph of Tang Palace (China) Holdings' past earnings, revenue and cash flow.

The Trend Of ROCE

We are a bit anxious about the trends of ROCE at Tang Palace (China) Holdings. To be more specific, today's ROCE was 34% five years ago but has since fallen to 6.1%. In addition to that, Tang Palace (China) Holdings is now employing 40% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Tang Palace (China) Holdings' current liabilities are still rather high at 50% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. This could explain why the stock has sunk a total of 74% in the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 4 warning signs with Tang Palace (China) Holdings (at least 1 which is concerning) , and understanding them would certainly be useful.

While Tang Palace (China) Holdings 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.