Should You Be Worried About Hongkong and Shanghai Hotels' (HKG:45) Returns On Capital?

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 glancing at the trends within Hongkong and Shanghai Hotels (HKG:45), we weren't too hopeful.

What is Return On Capital Employed (ROCE)?

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 Hongkong and Shanghai Hotels:

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

0.0021 = HK$104m ÷ (HK$52b - HK$2.7b) (Based on the trailing twelve months to June 2020).

Thus, Hongkong and Shanghai Hotels has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 3.3%.

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.

How Are Returns Trending?

In terms of Hongkong and Shanghai Hotels' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 2.5% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. 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.

What We Can Learn From Hongkong and Shanghai Hotels' ROCE

In summary, it's unfortunate that Hongkong and Shanghai Hotels is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 12% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing: We've identified 2 warning signs with Hongkong and Shanghai Hotels (at least 1 which can't be ignored) , and understanding them would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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