Here's What's Concerning About Cathay Group Holdings' (HKG:1981) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Cathay Group Holdings (HKG:1981) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Cathay Group Holdings:

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

0.03 = CN¥72m ÷ (CN¥2.7b - CN¥287m) (Based on the trailing twelve months to June 2024).

So, Cathay Group Holdings has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 11%.

View our latest analysis for Cathay Group Holdings

In the above chart we have measured Cathay Group Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Cathay Group Holdings for free.

What Can We Tell From Cathay Group Holdings' ROCE Trend?

On the surface, the trend of ROCE at Cathay Group Holdings doesn't inspire confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 3.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Cathay Group Holdings has decreased its current liabilities to 11% 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 Cathay Group Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Cathay Group Holdings. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Cathay Group Holdings could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for 1981 on our platform quite valuable.

While Cathay 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.