Does Highway Holdings' (NASDAQ:HIHO) Returns On Capital Reflect Well On The Business?

When researching a stock for investment, what can tell us that the company is in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Highway Holdings (NASDAQ:HIHO), we weren't too hopeful.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Highway Holdings, this is the formula:

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

0.089 = US$1.1m ÷ (US$17m - US$4.4m) (Based on the trailing twelve months to September 2020).

Thus, Highway Holdings has an ROCE of 8.9%. In absolute terms, that's a low return but it's around the Machinery industry average of 10%.

Check out our latest analysis for Highway Holdings

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

How Are Returns Trending?

In terms of Highway Holdings' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 12%, however they're now substantially lower than that as we saw above. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Highway Holdings becoming one if things continue as they have.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. However the stock has delivered a 48% return to shareholders over the last five years, so investors might be expecting the trends to turn around. 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 4 warning signs for Highway Holdings (of which 1 doesn't sit too well with us!) that you should know about.

While Highway Holdings 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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