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. So after glancing at the trends within Jiangsu Hongdou IndustrialLTD (SHSE:600400), we weren't too hopeful.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Jiangsu Hongdou IndustrialLTD, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0066 = CN¥23m ÷ (CN¥5.1b - CN¥1.6b) (Based on the trailing twelve months to March 2024).
Therefore, Jiangsu Hongdou IndustrialLTD has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Luxury industry average of 6.7%.
Above you can see how the current ROCE for Jiangsu Hongdou IndustrialLTD compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Jiangsu Hongdou IndustrialLTD .
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Jiangsu Hongdou IndustrialLTD, given the returns are trending downwards. About five years ago, returns on capital were 3.7%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Jiangsu Hongdou IndustrialLTD becoming one if things continue as they have.
The Bottom Line
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. It should come as no surprise then that the stock has fallen 23% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing to note, we've identified 1 warning sign with Jiangsu Hongdou IndustrialLTD and understanding it should be part of your investment process.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.