Some Investors May Be Worried About Trio Industrial Electronics Group's (HKG:1710) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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, from a first glance at Trio Industrial Electronics Group (HKG:1710) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Trio Industrial Electronics Group is:

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

0.12 = HK$46m ÷ (HK$544m - HK$159m) (Based on the trailing twelve months to December 2020).

Thus, Trio Industrial Electronics Group has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 8.1% generated by the Electronic industry.

View our latest analysis for Trio Industrial Electronics Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Trio Industrial Electronics Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Trio Industrial Electronics Group, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Trio Industrial Electronics Group, we didn't gain much confidence. Around five years ago the returns on capital were 41%, but since then they've fallen to 12%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Trio Industrial Electronics Group has decreased its current liabilities to 29% 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 Trio Industrial Electronics Group's ROCE

In summary, we're somewhat concerned by Trio Industrial Electronics Group's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 56% from where it was three years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing: We've identified 4 warning signs with Trio Industrial Electronics Group (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

While Trio Industrial Electronics Group 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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