When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Huabao International Holdings (HKG:336), so let's see why.

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. Analysts use this formula to calculate it for Huabao International Holdings:

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

0.029 = CN¥424m ÷ (CN¥16b - CN¥1.4b) (Based on the trailing twelve months to December 2023).

Thus, Huabao International Holdings has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.2%.

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 International Holdings has performed in the past in other metrics, you can view this free graph of Huabao International Holdings' past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Huabao International Holdings' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 10%, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Huabao International Holdings becoming one if things continue as they have.

In Conclusion...

In summary, it's unfortunate that Huabao International Holdings is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 20% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to continue researching Huabao International Holdings, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Huabao International Holdings 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.

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