Capital Allocation Trends At Orange Tour Cultural Holding (HKG:8627) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Orange Tour Cultural Holding (HKG:8627), it didn't seem to tick all of these boxes.

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 Orange Tour Cultural Holding, this is the formula:

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

0.042 = CN¥3.8m ÷ (CN¥99m - CN¥8.7m) (Based on the trailing twelve months to September 2020).

Thus, Orange Tour Cultural Holding has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Media industry average of 10%.

See our latest analysis for Orange Tour Cultural Holding

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Orange Tour Cultural Holding has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Orange Tour Cultural Holding's ROCE Trending?

When we looked at the ROCE trend at Orange Tour Cultural Holding, we didn't gain much confidence. Around three years ago the returns on capital were 59%, but since then they've fallen to 4.2%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Orange Tour Cultural Holding has done well to pay down its current liabilities to 8.8% 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 Orange Tour Cultural Holding's ROCE

We're a bit apprehensive about Orange Tour Cultural Holding because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 39% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing Orange Tour Cultural Holding we've found 3 warning signs (1 shouldn't be ignored!) 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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