Hongkong and Shanghai Hotels (HKG:45) Could Be At Risk Of Shrinking As A Company

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. 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. So after we looked into Hongkong and Shanghai Hotels (HKG:45), the trends above didn't look too great.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Hongkong and Shanghai Hotels:

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

0.0045 = HK$241m ÷ (HK$58b - HK$5.2b) (Based on the trailing twelve months to June 2023).

Therefore, Hongkong and Shanghai Hotels has an ROCE of 0.5%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 3.8%.

View our latest analysis for Hongkong and Shanghai Hotels

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

What Can We Tell From Hongkong and Shanghai Hotels' ROCE Trend?

There is reason to be cautious about Hongkong and Shanghai Hotels, given the returns are trending downwards. About five years ago, returns on capital were 2.3%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Hongkong and Shanghai Hotels to turn into a multi-bagger.

Our Take On Hongkong and Shanghai Hotels' ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 51% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know about the risks facing Hongkong and Shanghai Hotels, we've discovered 2 warning signs that you should be aware of.

While Hongkong and Shanghai Hotels 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.