Capital Allocation Trends At Sheen Tai Holdings Group (HKG:1335) Aren't Ideal

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. In light of that, from a first glance at Sheen Tai Holdings Group (HKG:1335), we've spotted some signs that it could be struggling, so let's investigate.

What Is Return On Capital Employed (ROCE)?

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 Sheen Tai Holdings Group is:

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

0.003 = HK$2.2m ÷ (HK$753m - HK$23m) (Based on the trailing twelve months to June 2024).

So, Sheen Tai Holdings Group has an ROCE of 0.3%. Ultimately, that's a low return and it under-performs the Electronic industry average of 7.9%.

Check out our latest analysis for Sheen Tai Holdings Group

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

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Sheen Tai Holdings Group. Unfortunately the returns on capital have diminished from the 0.6% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Sheen Tai Holdings Group becoming one if things continue as they have.

On a related note, Sheen Tai Holdings Group has decreased its current liabilities to 3.0% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

In summary, it's unfortunate that Sheen Tai Holdings Group is generating lower returns from the same amount of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 124%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you'd like to know more about Sheen Tai Holdings Group, we've spotted 2 warning signs, and 1 of them is a bit unpleasant.

While Sheen Tai Holdings Group 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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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.