The Returns On Capital At Tang Palace (China) Holdings (HKG:1181) Don't Inspire Confidence

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Although, when we looked at Tang Palace (China) Holdings (HKG:1181), it didn't seem to tick all of these boxes.

Understanding 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 Tang Palace (China) Holdings:

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

0.091 = CN¥54m ÷ (CN¥1.1b - CN¥471m) (Based on the trailing twelve months to December 2020).

Therefore, Tang Palace (China) Holdings has an ROCE of 9.1%. In absolute terms, that's a low return, but it's much better than the Hospitality industry average of 3.3%.

See our latest analysis for Tang Palace (China) 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'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 past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Tang Palace (China) Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.1% from 33% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 side note, Tang Palace (China) Holdings' current liabilities are still rather high at 44% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Tang Palace (China) Holdings' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Tang Palace (China) Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 91% return to shareholders over the last five years, so investors might be expecting the trends to turn around. 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 4 warning signs we've spotted with Tang Palace (China) Holdings (including 1 which is a bit unpleasant) .

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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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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