When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into Hongkong and Shanghai Hotels (HKG:45), we weren't too upbeat about how things were going.
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. Analysts use this formula to calculate it for Hongkong and Shanghai Hotels:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.011 = HK$578m ÷ (HK$58b - HK$4.7b) (Based on the trailing twelve months to December 2023).
Therefore, Hongkong and Shanghai Hotels has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 6.1%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hongkong and Shanghai Hotels.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at Hongkong and Shanghai Hotels. Unfortunately the returns on capital have diminished from the 2.2% 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Hongkong and Shanghai Hotels becoming one if things continue as they have.
Our Take On Hongkong and Shanghai Hotels' ROCE
In summary, it's unfortunate that Hongkong and Shanghai Hotels is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 44% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with Hongkong and Shanghai Hotels (including 2 which are a bit unpleasant) .
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.