The Trends At Tang Palace (China) Holdings (HKG:1181) That You Should Know About

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. Having said that, while the ROCE is currently high for Tang Palace (China) Holdings (HKG:1181), we aren't jumping out of our chairs because returns are decreasing.

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. The formula for this calculation on Tang Palace (China) Holdings is:

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

0.21 = CN¥117m ÷ (CN¥1.0b - CN¥472m) (Based on the trailing twelve months to June 2020).

Thus, Tang Palace (China) Holdings has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Hospitality industry average of 3.5%.

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're interested in investigating Tang Palace (China) Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Tang Palace (China) Holdings' ROCE Trend?

On the surface, the trend of ROCE at Tang Palace (China) Holdings doesn't inspire confidence. Historically returns on capital were even higher at 42%, but they have dropped over the last five years. 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 side note, Tang Palace (China) Holdings' current liabilities are still rather high at 46% 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

In summary, we're somewhat concerned by Tang Palace (China) Holdings' diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 101% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 1 warning sign for Tang Palace (China) Holdings you'll probably want to know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

When trading Tang Palace (China) Holdings or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.