Capital Allocation Trends At SJM Holdings (HKG:880) Aren't Ideal

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into SJM Holdings (HKG:880), the trends above didn't look too great.

Understanding 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. To calculate this metric for SJM Holdings, this is the formula:

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

0.025 = HK$1.1b ÷ (HK$48b - HK$5.2b) (Based on the trailing twelve months to June 2024).

Thus, SJM Holdings has an ROCE of 2.5%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 6.9%.

See our latest analysis for SJM Holdings

Above you can see how the current ROCE for SJM Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering SJM Holdings for free.

What The Trend Of ROCE Can Tell Us

In terms of SJM Holdings' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 6.6%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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. If these trends continue, we wouldn't expect SJM Holdings to turn into a multi-bagger.

On a side note, SJM Holdings has done well to pay down its current liabilities to 11% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From SJM Holdings' ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 65% 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.

If you want to continue researching SJM Holdings, you might be interested to know about the 1 warning sign that our analysis has discovered.

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. 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.