Be Wary Of Wonderful Sky Financial Group Holdings (HKG:1260) And Its Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Wonderful Sky Financial Group Holdings (HKG:1260), it didn't seem to tick all of these boxes.

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

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 Wonderful Sky Financial Group Holdings is:

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

0.007 = HK$11m ÷ (HK$2.0b - HK$358m) (Based on the trailing twelve months to March 2021).

So, Wonderful Sky Financial Group Holdings has an ROCE of 0.7%. In absolute terms, that's a low return and it also under-performs the Media industry average of 5.9%.

See our latest analysis for Wonderful Sky Financial Group Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Wonderful Sky Financial Group Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Wonderful Sky Financial Group Holdings, check out these free graphs here.

What Can We Tell From Wonderful Sky Financial Group Holdings' ROCE Trend?

In terms of Wonderful Sky Financial Group Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 0.7% from 19% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

In Conclusion...

In summary, we're somewhat concerned by Wonderful Sky Financial Group Holdings' diminishing returns on increasing amounts of capital. This could explain why the stock has sunk a total of 81% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Wonderful Sky Financial Group Holdings does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

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. 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.
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