To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Hengan International Group (HKG:1044), we've spotted some signs that it could be struggling, so let's investigate.

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. The formula for this calculation on Hengan International Group is:

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

0.15 = CN¥3.1b ÷ (CN¥48b - CN¥28b) (Based on the trailing twelve months to June 2023).

Thus, Hengan International Group has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Personal Products industry average of 13%.

View our latest analysis for Hengan International Group

Above you can see how the current ROCE for Hengan International Group 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 report on analyst forecasts for the company.

What Does the ROCE Trend For Hengan International Group Tell Us?

There is reason to be cautious about Hengan International Group, given the returns are trending downwards. About five years ago, returns on capital were 23%, 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Hengan International Group to turn into a multi-bagger.

On a side note, Hengan International Group's current liabilities have increased over the last five years to 57% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 15%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

In summary, it's unfortunate that Hengan International Group is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 48% 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.

On a separate note, we've found 2 warning signs for Hengan International Group you'll probably want to know about.

While Hengan International Group 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.