Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into Shenzhen Topway Video Communication (SZSE:002238), the trends above didn't look too great.

Understanding 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. Analysts use this formula to calculate it for Shenzhen Topway Video Communication:

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

0.0077 = CN¥21m ÷ (CN¥4.3b - CN¥1.6b) (Based on the trailing twelve months to March 2024).

So, Shenzhen Topway Video Communication has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Media industry average of 4.0%.

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

What Can We Tell From Shenzhen Topway Video Communication's ROCE Trend?

We are a bit worried about the trend of returns on capital at Shenzhen Topway Video Communication. To be more specific, the ROCE was 4.6% five years ago, but since then it has dropped noticeably. 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 Shenzhen Topway Video Communication becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 38%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 0.8%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

In Conclusion...

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. However the stock has delivered a 66% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we found 3 warning signs for Shenzhen Topway Video Communication (1 doesn't sit too well with us) you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.

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