Is Rich Honour International Designs (TPE:6754) Likely To Turn Things Around?

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Rich Honour International Designs (TPE:6754) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Rich Honour International Designs is:

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

0.13 = NT$281m ÷ (NT$3.7b - NT$1.5b) (Based on the trailing twelve months to September 2020).

Therefore, Rich Honour International Designs has an ROCE of 13%. That's a pretty standard return and it's in line with the industry average of 13%.

Check out our latest analysis for Rich Honour International Designs

Historical performance is a great place to start when researching a stock so above you can see the gauge for Rich Honour International Designs' ROCE against it's prior returns. If you're interested in investigating Rich Honour International Designs' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Rich Honour International Designs' ROCE Trend?

We weren't thrilled with the trend because Rich Honour International Designs' ROCE has reduced by 49% over the last three years, while the business employed 248% more capital. Usually this isn't ideal, but given Rich Honour International Designs conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Rich Honour International Designs might not have received a full period of earnings contribution from it.

On a side note, Rich Honour International Designs has done well to pay down its current liabilities to 40% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 40% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

We're a bit apprehensive about Rich Honour International Designs because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors must expect better things on the horizon though because the stock has risen 3.2% in the last year. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing to note, we've identified 2 warning signs with Rich Honour International Designs and understanding these should be part of your investment process.

While Rich Honour International Designs 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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This article by Simply Wall St is general in nature. 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.
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