Capital Allocation Trends At Wonderful Sky Financial Group Holdings (HKG:1260) 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? 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Wonderful Sky Financial Group Holdings (HKG:1260), we weren't too hopeful.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Wonderful Sky Financial Group Holdings, this is the formula:

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

0.018 = HK$26m ÷ (HK$1.6b - HK$121m) (Based on the trailing twelve months to March 2024).

So, Wonderful Sky Financial Group Holdings has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Media industry average of 8.0%.

Check out 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 Wonderful Sky Financial Group Holdings' past earnings, revenue and cash flow.

How Are Returns Trending?

There is reason to be cautious about Wonderful Sky Financial Group Holdings, given the returns are trending downwards. To be more specific, the ROCE was 13% five years ago, but since then it has dropped noticeably. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Wonderful Sky Financial Group Holdings becoming one if things continue as they have.

On a side note, Wonderful Sky Financial Group Holdings has done well to pay down its current liabilities to 7.6% 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.

In Conclusion...

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. Investors haven't taken kindly to these developments, since the stock has declined 66% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Wonderful Sky Financial Group Holdings (including 1 which is potentially serious) .

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.