The Returns On Capital At Wonderful Sky Financial Group Holdings (HKG:1260) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. In light of that, when we looked at Wonderful Sky Financial Group Holdings (HKG:1260) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)

0.018 = HK$28m ÷ (HK$1.7b - HK$160m) (Based on the trailing twelve months to September 2021).

So, Wonderful Sky Financial Group Holdings has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the Media industry average of 8.1%.

View 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.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Wonderful Sky Financial Group Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 1.8%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Wonderful Sky Financial Group Holdings has done well to pay down its current liabilities to 9.2% 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. 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

In summary, despite lower returns in the short term, we're encouraged to see that Wonderful Sky Financial Group Holdings is reinvesting for growth and has higher sales as a result. Despite these promising trends, the stock has collapsed 85% over the last five years, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

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

While Wonderful Sky Financial Group Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.