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Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Highway Holdings (NASDAQ:HIHO), we weren't too upbeat about how things were going.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 9.5%.
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're interested in investigating Highway Holdings' past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
We are a bit worried about the trend of returns on capital at Highway Holdings. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Highway Holdings becoming one if things continue as they have.
Our Take On Highway Holdings' 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. And long term shareholders have watched their investments stay flat over the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One final note, you should learn about the 5 warning signs we've spotted with Highway Holdings (including 1 which is a bit concerning) .
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.
This article by Simply Wall St is general in nature. 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.
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