Capital Allocation Trends At Ngai Hing Hong (HKG:1047) Aren't Ideal

What underlying fundamental trends can indicate that a company might be 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 the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Ngai Hing Hong (HKG:1047) we aren't filled with optimism, but let's investigate further.

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. To calculate this metric for Ngai Hing Hong, this is the formula:

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

0.033 = HK$19m ÷ (HK$996m - HK$414m) (Based on the trailing twelve months to December 2022).

Thus, Ngai Hing Hong has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 14%.

See our latest analysis for Ngai Hing Hong

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

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Ngai Hing Hong, given the returns are trending downwards. To be more specific, the ROCE was 12% five years ago, but since then it has dropped noticeably. 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 Ngai Hing Hong to turn into a multi-bagger.

On a side note, Ngai Hing Hong's current liabilities are still rather high at 42% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

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 31% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know about the risks facing Ngai Hing Hong, we've discovered 1 warning sign that you should be aware of.

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.