Here's What's Concerning About Topsports International Holdings' (HKG:6110) Returns On 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, while the ROCE is currently high for Topsports International Holdings (HKG:6110), we aren't jumping out of our chairs because returns are decreasing.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Topsports International Holdings:

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

0.25 = CN¥3.0b ÷ (CN¥18b - CN¥5.6b) (Based on the trailing twelve months to August 2022).

So, Topsports International Holdings has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 11%.

View our latest analysis for Topsports International Holdings

In the above chart we have measured Topsports International Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Topsports International Holdings' ROCE Trending?

When we looked at the ROCE trend at Topsports International Holdings, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 35% where it was five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Topsports International Holdings has done well to pay down its current liabilities to 32% of total assets. So we could link some of this to the decrease in ROCE. 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.

Our Take On Topsports International Holdings' ROCE

We're a bit apprehensive about Topsports International Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 19% over the last three 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.

On a final note, we've found 1 warning sign for Topsports International Holdings that we think you should be aware of.

Topsports International Holdings is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.