What underlying fundamental trends can indicate that a company might be in decline? 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Brilliance Technology (SZSE:300542), 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. The formula for this calculation on Brilliance Technology is:

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

0.068 = CN¥44m ÷ (CN¥1.4b - CN¥798m) (Based on the trailing twelve months to September 2024).

Thus, Brilliance Technology has an ROCE of 6.8%. On its own that's a low return, but compared to the average of 3.7% generated by the IT industry, it's much better.

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 Brilliance Technology has performed in the past in other metrics, you can view this free graph of Brilliance Technology's past earnings, revenue and cash flow.

So How Is Brilliance Technology's ROCE Trending?

There is reason to be cautious about Brilliance Technology, given the returns are trending downwards. To be more specific, the ROCE was 9.0% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Brilliance Technology to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 56%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 6.8%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

In summary, it's unfortunate that Brilliance Technology is generating lower returns from the same amount of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 103%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Brilliance Technology (including 2 which don't sit too well with us) .

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.