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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Shenzhen Topway Video Communication (SZSE:002238), 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. The formula for this calculation on Shenzhen Topway Video Communication is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0048 = CN¥13m ÷ (CN¥4.1b - CN¥1.5b) (Based on the trailing twelve months to September 2023).
So, Shenzhen Topway Video Communication has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Media industry average of 4.9%.
View our latest analysis for Shenzhen Topway Video Communication
Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenzhen Topway Video Communication's ROCE against it's prior returns. If you'd like to look at how Shenzhen Topway Video Communication 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
In terms of Shenzhen Topway Video Communication's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 5.8%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Shenzhen Topway Video Communication becoming one if things continue as they have.
On a side note, Shenzhen Topway Video Communication's current liabilities have increased over the last five years to 36% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 0.5%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
Our Take On Shenzhen Topway Video Communication's ROCE
In summary, it's unfortunate that Shenzhen Topway Video Communication 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 176%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Shenzhen Topway Video Communication does have some risks, we noticed 4 warning signs (and 2 which are significant) we think you should know about.
While Shenzhen Topway Video Communication may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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.
