If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Jiangsu Sunshine (SHSE:600220), we weren't too upbeat about how things were going.
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. The formula for this calculation on Jiangsu Sunshine is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = CN¥161m ÷ (CN¥4.3b - CN¥2.0b) (Based on the trailing twelve months to September 2023).
Thus, Jiangsu Sunshine has an ROCE of 7.0%. On its own that's a low return, but compared to the average of 5.1% generated by the Luxury industry, it's much better.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Jiangsu Sunshine's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Jiangsu Sunshine, check out these free graphs here.
What Can We Tell From Jiangsu Sunshine's ROCE Trend?
There is reason to be cautious about Jiangsu Sunshine, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 9.9% that they were earning five years ago. 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 Jiangsu Sunshine to turn into a multi-bagger.
On a separate but related note, it's important to know that Jiangsu Sunshine has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line
In summary, it's unfortunate that Jiangsu Sunshine is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 19% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Jiangsu Sunshine (of which 2 shouldn't be ignored!) that you should know about.
While Jiangsu Sunshine may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.