When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after we looked into YOOZOO Interactive (SZSE:002174), the trends above didn't look too great.

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 YOOZOO Interactive is:

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

0.027 = CN¥142m ÷ (CN¥6.1b - CN¥752m) (Based on the trailing twelve months to March 2024).

So, YOOZOO Interactive has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 5.2%.

In the above chart we have measured YOOZOO Interactive's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for YOOZOO Interactive .

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at YOOZOO Interactive. To be more specific, the ROCE was 16% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on YOOZOO Interactive becoming one if things continue as they have.

On a related note, YOOZOO Interactive has decreased its current liabilities to 12% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From YOOZOO Interactive's ROCE

In summary, it's unfortunate that YOOZOO Interactive is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 50% 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.

Like most companies, YOOZOO Interactive does come with some risks, and we've found 1 warning sign that you should be aware of.

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.

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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.