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. So after glancing at the trends within Leyard Optoelectronic (SZSE:300296), we weren't too hopeful.

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. To calculate this metric for Leyard Optoelectronic, this is the formula:

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

0.028 = CN¥272m ÷ (CN¥15b - CN¥4.8b) (Based on the trailing twelve months to March 2024).

Therefore, Leyard Optoelectronic has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 5.2%.

In the above chart we have measured Leyard Optoelectronic's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Leyard Optoelectronic for free.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Leyard Optoelectronic. To be more specific, the ROCE was 17% 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Leyard Optoelectronic becoming one if things continue as they have.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 31% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

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

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.