There Are Reasons To Feel Uneasy About Sunlight (1977) Holdings' (HKG:8451) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Sunlight (1977) Holdings (HKG:8451) 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Sunlight (1977) Holdings is:

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

0.026 = S$472k ÷ (S$19m - S$1.2m) (Based on the trailing twelve months to June 2023).

Thus, Sunlight (1977) Holdings has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Retail Distributors industry average of 5.3%.

Check out our latest analysis for Sunlight (1977) Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Sunlight (1977) Holdings, check out these free graphs here.

The Trend Of ROCE

On the surface, the trend of ROCE at Sunlight (1977) Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.6% from 15% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Sunlight (1977) Holdings has decreased its current liabilities to 6.2% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Sunlight (1977) Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sunlight (1977) Holdings. And the stock has done incredibly well with a 127% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing, we've spotted 2 warning signs facing Sunlight (1977) Holdings that you might find interesting.

While Sunlight (1977) Holdings 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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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.