There Are Reasons To Feel Uneasy About Topsports International Holdings' (HKG:6110) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. 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.

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 Topsports International Holdings:

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

0.22 = CN¥2.5b ÷ (CN¥17b - CN¥5.3b) (Based on the trailing twelve months to February 2023).

So, Topsports International Holdings has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 9.0%.

Check out 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'd like, you can check out the forecasts from the analysts covering Topsports International Holdings here for free.

What Can We Tell From Topsports International Holdings' ROCE Trend?

In terms of Topsports International Holdings' historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 40%, but they have dropped over the last five years. 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 31% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Topsports International Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 18% over the last three 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.

Like most companies, Topsports International Holdings does come with some risks, and we've found 1 warning sign that 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.