When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at Wai Chi Holdings (HKG:1305), we've spotted some signs that it could be struggling, so let's investigate.
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 Wai Chi Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = HK$44m ÷ (HK$1.6b - HK$942m) (Based on the trailing twelve months to June 2020).
Therefore, Wai Chi Holdings has an ROCE of 6.3%. On its own, that's a low figure but it's around the 7.6% average generated by the Semiconductor industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Wai Chi Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Wai Chi Holdings, check out these free graphs here.
What Does the ROCE Trend For Wai Chi Holdings Tell Us?
There is reason to be cautious about Wai Chi Holdings, given the returns are trending downwards. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Wai Chi Holdings to turn into a multi-bagger.On a side note, Wai Chi Holdings' current liabilities are still rather high at 57% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Wai Chi Holdings' ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. We expect this has contributed to the stock plummeting 88% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a final note, we found 3 warning signs for Wai Chi Holdings (2 can't be ignored) you should be aware of.
While Wai Chi Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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Wai Chi Holdings
Wai Chi Holdings Company Limited, an investment holding company, manufactures and trades in light-emitting diode (LED) backlight and LED lighting products to business corporations and public utilities in the People’s Republic of China, Hong Kong, Taiwan, and internationally.
Excellent balance sheet with solid track record.