Capital Allocation Trends At Hanwha Ocean (KRX:042660) Aren't Ideal

When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into Hanwha Ocean (KRX:042660), the trends above didn't look too great.

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 Hanwha Ocean is:

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

0.0034 = ₩22b ÷ (₩16t - ₩9.9t) (Based on the trailing twelve months to September 2024).

Thus, Hanwha Ocean has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.7%.

Check out our latest analysis for Hanwha Ocean

In the above chart we have measured Hanwha Ocean's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Hanwha Ocean .

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Hanwha Ocean, given the returns are trending downwards. About five years ago, returns on capital were 7.2%, however they're now substantially lower than that as we saw above. 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 Hanwha Ocean to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 61%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

What We Can Learn From Hanwha Ocean's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 479%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Hanwha Ocean (of which 2 don't sit too well with us!) that you should know about.

While Hanwha Ocean 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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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.