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To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. 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 glancing at the trends within Hong Leong Asia (SGX:H22), we weren't too hopeful.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Hong Leong Asia is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = S$99m ÷ (S$5.9b - S$2.9b) (Based on the trailing twelve months to June 2024).
Therefore, Hong Leong Asia has an ROCE of 3.3%. 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 Hong Leong Asia
Above you can see how the current ROCE for Hong Leong Asia compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Hong Leong Asia .
What Does the ROCE Trend For Hong Leong Asia Tell Us?
There is reason to be cautious about Hong Leong Asia, given the returns are trending downwards. About five years ago, returns on capital were 7.3%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Hong Leong Asia becoming one if things continue as they have.
Another thing to note, Hong Leong Asia has a high ratio of current liabilities to total assets of 49%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Hong Leong Asia'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. However the stock has delivered a 89% 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.