What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at Jiangsu Yawei Machine Tool (SZSE:002559), so let's see why.
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. Analysts use this formula to calculate it for Jiangsu Yawei Machine Tool:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = CN¥53m ÷ (CN¥4.5b - CN¥2.4b) (Based on the trailing twelve months to September 2023).
Thus, Jiangsu Yawei Machine Tool has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.1%.
View our latest analysis for Jiangsu Yawei Machine Tool
Above you can see how the current ROCE for Jiangsu Yawei Machine Tool compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Jiangsu Yawei Machine Tool here for free.
So How Is Jiangsu Yawei Machine Tool's ROCE Trending?
We are a bit worried about the trend of returns on capital at Jiangsu Yawei Machine Tool. To be more specific, the ROCE was 9.1% 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 Jiangsu Yawei Machine Tool to turn into a multi-bagger.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 54%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 2.6%. 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
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these poor fundamentals, the stock has gained a huge 139% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Jiangsu Yawei Machine Tool does come with some risks though, we found 5 warning signs in our investment analysis, and 2 of those can't be ignored...
While Jiangsu Yawei Machine Tool isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.