ELL Environmental Holdings (HKG:1395) Could Be Struggling To Allocate Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, ELL Environmental Holdings (HKG:1395) we aren't filled with optimism, but let's investigate further.

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 ELL Environmental Holdings:

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

0.013 = HK$5.6m ÷ (HK$511m - HK$76m) (Based on the trailing twelve months to June 2021).

So, ELL Environmental Holdings has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Water Utilities industry average of 7.5%.

See our latest analysis for ELL Environmental 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're interested in investigating ELL Environmental Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

The trend of returns that ELL Environmental Holdings is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 1.3% we see today. On top of that, the business is utilizing 21% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

In Conclusion...

To see ELL Environmental Holdings reducing the capital employed in the business in tandem with diminishing returns, is concerning. Long term shareholders who've owned the stock over the last five years have experienced a 70% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

ELL Environmental Holdings does have some risks, we noticed 3 warning signs (and 1 which is potentially serious) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.