To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. So after we looked into Fanli Digital TechnologyLtd (SHSE:600228), the trends above didn't look too great.

Return On Capital Employed (ROCE): What Is It?

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 Fanli Digital TechnologyLtd:

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

0.069 = CN¥36m ÷ (CN¥634m - CN¥109m) (Based on the trailing twelve months to September 2024).

Therefore, Fanli Digital TechnologyLtd has an ROCE of 6.9%. In absolute terms, that's a low return but it's around the Interactive Media and Services 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 Fanli Digital TechnologyLtd has performed in the past in other metrics, you can view this free graph of Fanli Digital TechnologyLtd's past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Fanli Digital TechnologyLtd's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 15% five years ago but has since fallen to 6.9%. On top of that, the business is utilizing 25% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Fanli Digital TechnologyLtd has done well to pay down its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

To see Fanli Digital TechnologyLtd reducing the capital employed in the business in tandem with diminishing returns, is concerning. Investors must expect better things on the horizon though because the stock has risen 4.3% in the last three years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Fanli Digital TechnologyLtd (of which 1 doesn't sit too well with us!) that you should know about.

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.