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 indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into China Reform Culture Holdings (SHSE:600636), we weren't too upbeat about how things were going.

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 China Reform Culture Holdings is:

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

0.013 = CN¥34m ÷ (CN¥2.7b - CN¥122m) (Based on the trailing twelve months to March 2022).

Therefore, China Reform Culture Holdings has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 9.8%.

View our latest analysis for China Reform Culture Holdings

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 China Reform Culture Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

The trend of ROCE at China Reform Culture Holdings is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 1.3% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 21% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, China Reform Culture Holdings has done well to pay down its current liabilities to 4.5% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On China Reform Culture Holdings' ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Long term shareholders who've owned the stock over the last five years have experienced a 45% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

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

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.