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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, Songz Automobile Air Conditioning (SZSE:002454) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Songz Automobile Air Conditioning, this is the formula:

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

0.031 = CN¥139m ÷ (CN¥7.3b - CN¥2.9b) (Based on the trailing twelve months to September 2023).

Therefore, Songz Automobile Air Conditioning has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 6.1%.

Check out our latest analysis for Songz Automobile Air Conditioning

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Songz Automobile Air Conditioning's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Songz Automobile Air Conditioning Tell Us?

We are a bit worried about the trend of returns on capital at Songz Automobile Air Conditioning. About five years ago, returns on capital were 8.5%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. If these trends continue, we wouldn't expect Songz Automobile Air Conditioning to turn into a multi-bagger.

The Key Takeaway

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. Yet despite these concerning fundamentals, the stock has performed strongly with a 98% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to continue researching Songz Automobile Air Conditioning, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Songz Automobile Air Conditioning 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.