Here's What's Concerning About Luk Fook Holdings (International)'s (HKG:590) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after briefly looking over the numbers, we don't think Luk Fook Holdings (International) (HKG:590) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Luk Fook Holdings (International) is:

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

0.074 = HK$813m ÷ (HK$13b - HK$2.4b) (Based on the trailing twelve months to September 2020).

Therefore, Luk Fook Holdings (International) has an ROCE of 7.4%. In absolute terms, that's a low return but it's around the Specialty Retail industry average of 9.2%.

See our latest analysis for Luk Fook Holdings (International)

Above you can see how the current ROCE for Luk Fook Holdings (International) compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Luk Fook Holdings (International).

The Trend Of ROCE

On the surface, the trend of ROCE at Luk Fook Holdings (International) doesn't inspire confidence. To be more specific, ROCE has fallen from 19% over the last five years. 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.

What We Can Learn From Luk Fook Holdings (International)'s ROCE

In summary, we're somewhat concerned by Luk Fook Holdings (International)'s diminishing returns on increasing amounts of capital. However the stock has delivered a 64% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 1 warning sign with Luk Fook Holdings (International) and understanding it should be part of your investment process.

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.

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This article by Simply Wall St is general in nature. 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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