Hongkong and Shanghai Hotels (HKG:45) Will Be Hoping To Turn Its Returns On Capital Around

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, Hongkong and Shanghai Hotels (HKG:45) we aren't filled with optimism, but let's investigate further.

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What Is 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. The formula for this calculation on Hongkong and Shanghai Hotels is:

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

0.013 = HK$658m ÷ (HK$56b - HK$5.7b) (Based on the trailing twelve months to June 2024).

So, Hongkong and Shanghai Hotels has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 6.9%.

Check out 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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hongkong and Shanghai Hotels.

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

We are a bit worried about the trend of returns on capital at Hongkong and Shanghai Hotels. Unfortunately the returns on capital have diminished from the 2.0% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Hongkong and Shanghai Hotels becoming one if things continue as they have.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Long term shareholders who've owned the stock over the last five years have experienced a 11% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we found 2 warning signs for Hongkong and Shanghai Hotels (1 is potentially serious) 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.