Here's What's Concerning About Wonderful Sky Financial Group Holdings' (HKG:1260) Returns On Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after we looked into Wonderful Sky Financial Group Holdings (HKG:1260), the trends above didn't look too great.

Understanding 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 Wonderful Sky Financial Group Holdings, this is the formula:

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

0.017 = HK$24m ÷ (HK$1.6b - HK$121m) (Based on the trailing twelve months to March 2024).

Therefore, Wonderful Sky Financial Group Holdings has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Media industry average of 9.0%.

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.

So How Is Wonderful Sky Financial Group Holdings' ROCE Trending?

We are a bit worried about the trend of returns on capital at Wonderful Sky Financial Group Holdings. To be more specific, the ROCE was 13% 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. 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 related note, Wonderful Sky Financial Group Holdings has decreased its current liabilities to 7.6% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Wonderful Sky Financial Group Holdings' ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. This could explain why the stock has sunk a total of 84% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to know some of the risks facing Wonderful Sky Financial Group Holdings we've found 2 warning signs (1 is concerning!) that you should be aware of before investing here.

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.

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