When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Lifestyle International Holdings (HKG:1212), we've spotted some signs that it could be struggling, so let's investigate.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Lifestyle International Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.052 = HK$781m ÷ (HK$26b - HK$11b) (Based on the trailing twelve months to December 2020).
Thus, Lifestyle International Holdings has an ROCE of 5.2%. In absolute terms, that's a low return and it also under-performs the Multiline Retail industry average of 7.2%.
In the above chart we have measured Lifestyle International Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Lifestyle International Holdings.
What The Trend Of ROCE Can Tell Us
In terms of Lifestyle International Holdings' historical ROCE trend, it isn't fantastic. The company used to generate 8.8% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 34% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
On a side note, Lifestyle International Holdings' current liabilities have increased over the last five years to 42% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Bottom Line On Lifestyle International Holdings' ROCE
To see Lifestyle International Holdings reducing the capital employed in the business in tandem with diminishing returns, is concerning. It should come as no surprise then that the stock has fallen 12% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with Lifestyle International Holdings (including 1 which shouldn't be ignored) .
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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