What underlying fundamental trends can indicate that a company might be in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Henan Huanghe Whirlwind (SHSE:600172), the trends above didn't look too great.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Henan Huanghe Whirlwind, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = CN¥55m ÷ (CN¥10.0b - CN¥6.0b) (Based on the trailing twelve months to June 2023).
So, Henan Huanghe Whirlwind has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.4%.
View our latest analysis for Henan Huanghe Whirlwind
Historical performance is a great place to start when researching a stock so above you can see the gauge for Henan Huanghe Whirlwind's ROCE against it's prior returns. If you'd like to look at how Henan Huanghe Whirlwind has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
We are a bit anxious about the trends of ROCE at Henan Huanghe Whirlwind. Unfortunately, returns have declined substantially over the last five years to the 1.4% we see today. In addition to that, Henan Huanghe Whirlwind is now employing 43% less capital than it was five years ago. 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. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 60%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.4%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
The Bottom Line On Henan Huanghe Whirlwind's ROCE
To see Henan Huanghe Whirlwind reducing the capital employed in the business in tandem with diminishing returns, is concerning. In spite of that, the stock has delivered a 9.2% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
On a separate note, we've found 1 warning sign for Henan Huanghe Whirlwind you'll probably want to know about.
While Henan Huanghe Whirlwind isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
