When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. Having said that, after a brief look, Second Chance Properties (SGX:528) we aren't filled with optimism, but let's investigate further.
What is 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 Second Chance Properties is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = S$8.0m ÷ (S$283m - S$34m) (Based on the trailing twelve months to August 2020).
Therefore, Second Chance Properties has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 9.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Second Chance Properties' ROCE against it's prior returns. If you'd like to look at how Second Chance Properties has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We are a bit worried about the trend of returns on capital at Second Chance Properties. Unfortunately the returns on capital have diminished from the 5.8% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Second Chance Properties to turn into a multi-bagger.
On a related note, Second Chance Properties has decreased its current liabilities to 12% 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.
The Key Takeaway
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. Despite the concerning underlying trends, the stock has actually gained 24% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Second Chance Properties does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is potentially serious...
While Second Chance Properties 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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