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. 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 indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Hong Leong Asia (SGX:H22) we aren't filled with optimism, but let's investigate further.

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. Analysts use this formula to calculate it for Hong Leong Asia:

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).

Thus, 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 7.0%.

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 .

So How Is Hong Leong Asia's ROCE Trending?

There is reason to be cautious about Hong Leong Asia, given the returns are trending downwards. To be more specific, the ROCE was 7.3% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Hong Leong Asia to turn into a multi-bagger.

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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Hong Leong Asia's ROCE

In summary, it's unfortunate that Hong Leong Asia is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 55% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.