NNK Group (HKG:3773) Could Be At Risk Of Shrinking As A Company

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into NNK Group (HKG:3773), we weren't too upbeat about how things were going.

Understanding 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 NNK Group:

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

0.13 = CN¥30m ÷ (CN¥354m - CN¥119m) (Based on the trailing twelve months to June 2021).

Therefore, NNK Group has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 12% generated by the Online Retail industry.

See our latest analysis for NNK Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for NNK Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of NNK Group, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

In terms of NNK Group's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 23%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on NNK Group becoming one if things continue as they have.

On a related note, NNK Group has decreased its current liabilities to 34% 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 NNK Group's ROCE

In summary, it's unfortunate that NNK Group is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 56% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with NNK Group (including 1 which can't be ignored) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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.

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