New World Department Store China (HKG:825) 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. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within New World Department Store China (HKG:825), we weren't too hopeful.

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 New World Department Store China:

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

0.0077 = HK$70m ÷ (HK$14b - HK$4.7b) (Based on the trailing twelve months to December 2020).

Thus, New World Department Store China has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Multiline Retail industry average of 5.6%.

Check out our latest analysis for New World Department Store China

Historical performance is a great place to start when researching a stock so above you can see the gauge for New World Department Store China's ROCE against it's prior returns. If you'd like to look at how New World Department Store China has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of New World Department Store China's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 3.5%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on New World Department Store China becoming one if things continue as they have.

The Key Takeaway

In summary, it's unfortunate that New World Department Store China is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 73% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

New World Department Store China does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...

While New World Department Store China may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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