Litian Pictures Holdings (HKG:9958) Could Be Struggling To Allocate Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Litian Pictures Holdings (HKG:9958) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Litian Pictures Holdings is:

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

0.077 = CN¥44m ÷ (CN¥1.1b - CN¥534m) (Based on the trailing twelve months to June 2021).

Thus, Litian Pictures Holdings has an ROCE of 7.7%. In absolute terms, that's a low return but it's around the Entertainment industry average of 9.2%.

See our latest analysis for Litian Pictures Holdings

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 want to delve into the historical earnings, revenue and cash flow of Litian Pictures Holdings, check out these free graphs here.

What Does the ROCE Trend For Litian Pictures Holdings Tell Us?

In terms of Litian Pictures Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 34% over the last three years. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Litian Pictures Holdings' current liabilities are still rather high at 48% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Litian Pictures Holdings' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Litian Pictures Holdings have fallen, meanwhile the business is employing more capital than it was three years ago. Long term shareholders who've owned the stock over the last year have experienced a 36% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 6 warning signs for Litian Pictures Holdings (of which 2 are concerning!) that you should know about.

While Litian Pictures 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.