Shenguan Holdings (Group) (HKG:829) May Have Issues Allocating Its Capital

When researching a stock for investment, what can tell us that the company is in decline? 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Shenguan Holdings (Group) (HKG:829), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

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 Shenguan Holdings (Group), this is the formula:

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

0.0057 = HK$15m ÷ (HK$3.1b - HK$422m) (Based on the trailing twelve months to December 2020).

So, Shenguan Holdings (Group) has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Food industry average of 13%.

See our latest analysis for Shenguan Holdings (Group)

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenguan Holdings (Group)'s ROCE against it's prior returns. If you'd like to look at how Shenguan Holdings (Group) has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

There is reason to be cautious about Shenguan Holdings (Group), given the returns are trending downwards. About five years ago, returns on capital were 19%, 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 Shenguan Holdings (Group) to turn into a multi-bagger.

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. It should come as no surprise then that the stock has fallen 26% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 3 warning signs with Shenguan Holdings (Group) (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.

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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