Capital Allocation Trends At Wonderful Sky Financial Group Holdings (HKG:1260) Aren't Ideal

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Wonderful Sky Financial Group Holdings (HKG:1260), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Wonderful Sky Financial Group Holdings:

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

0.022 = HK$32m ÷ (HK$1.6b - HK$137m) (Based on the trailing twelve months to March 2023).

So, Wonderful Sky Financial Group Holdings has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Media industry average of 11%.

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'd like to look at how Wonderful Sky Financial Group Holdings 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?

We are a bit worried about the trend of returns on capital at Wonderful Sky Financial Group Holdings. About five years ago, returns on capital were 6.7%, 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Wonderful Sky Financial Group Holdings to turn into a multi-bagger.

On a related note, Wonderful Sky Financial Group Holdings has decreased its current liabilities to 8.5% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Wonderful Sky Financial Group Holdings' ROCE

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. This could explain why the stock has sunk a total of 82% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know more about Wonderful Sky Financial Group Holdings, we've spotted 3 warning signs, and 1 of them doesn't sit too well with us.

While Wonderful Sky Financial Group Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.