If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Fanli Digital TechnologyLtd (SHSE:600228), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Fanli Digital TechnologyLtd:

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

0.013 = CN¥7.1m ÷ (CN¥697m - CN¥166m) (Based on the trailing twelve months to September 2023).

Therefore, Fanli Digital TechnologyLtd has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Interactive Media and Services industry average of 5.5%.

Check out our latest analysis for Fanli Digital TechnologyLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Fanli Digital TechnologyLtd's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Fanli Digital TechnologyLtd, check out these free graphs here.

How Are Returns Trending?

There is reason to be cautious about Fanli Digital TechnologyLtd, given the returns are trending downwards. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Fanli Digital TechnologyLtd to turn into a multi-bagger.

On a related note, Fanli Digital TechnologyLtd has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

In summary, it's unfortunate that Fanli Digital TechnologyLtd is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 7.4% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Fanli Digital TechnologyLtd does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

While Fanli Digital TechnologyLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.