Be Wary Of REF Holdings (HKG:1631) And Its Returns On Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 REF Holdings (HKG:1631), we've spotted some signs that it could be struggling, so let's investigate.

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Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for REF Holdings, this is the formula:

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

0.072 = HK$7.3m ÷ (HK$125m - HK$23m) (Based on the trailing twelve months to December 2024).

Therefore, REF Holdings has an ROCE of 7.2%. Even though it's in line with the industry average of 6.7%, it's still a low return by itself.

Check out our latest analysis for REF Holdings

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 REF Holdings.

What Does the ROCE Trend For REF Holdings Tell Us?

The trend of returns that REF Holdings is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 7.2% we see today. In addition to that, REF Holdings is now employing 59% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

The Bottom Line On REF Holdings' ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Since the stock has skyrocketed 315% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing REF Holdings we've found 4 warning signs (2 can't be ignored!) that you should be aware of before investing here.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.