Highway Holdings (NASDAQ:HIHO) May Have Issues Allocating Its Capital

What underlying fundamental trends can indicate that a company might be in decline? 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. So after we looked into Highway Holdings (NASDAQ:HIHO), the trends above didn't look too great.

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

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. Analysts use this formula to calculate it for Highway Holdings:

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

0.066 = US$789k ÷ (US$16m - US$3.9m) (Based on the trailing twelve months to December 2020).

Therefore, Highway Holdings has an ROCE of 6.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.1%.

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'd like to look at how Highway Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Highway Holdings. Unfortunately the returns on capital have diminished from the 11% that they were earning five years ago. 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 Highway Holdings to turn into a multi-bagger.

What We Can Learn From Highway Holdings' ROCE

In summary, it's unfortunate that Highway Holdings is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 16% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Highway Holdings (including 1 which is a bit unpleasant) .

While Highway Holdings 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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