When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Huabao Flavours & Fragrances (SZSE:300741) we aren't filled with optimism, but let's investigate further.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Huabao Flavours & Fragrances:

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

0.041 = CN¥312m ÷ (CN¥8.3b - CN¥594m) (Based on the trailing twelve months to September 2023).

Thus, Huabao Flavours & Fragrances has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.7%.

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'd like to look at how Huabao Flavours & Fragrances has performed in the past in other metrics, you can view this free graph of Huabao Flavours & Fragrances' past earnings, revenue and cash flow.

What Does the ROCE Trend For Huabao Flavours & Fragrances Tell Us?

There is reason to be cautious about Huabao Flavours & Fragrances, given the returns are trending downwards. About five years ago, returns on capital were 13%, 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. If these trends continue, we wouldn't expect Huabao Flavours & Fragrances to turn into a multi-bagger.

The Bottom Line

In summary, it's unfortunate that Huabao Flavours & Fragrances is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 27% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Huabao Flavours & Fragrances (including 1 which makes us a bit uncomfortable) .

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.