When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after we looked into Huachangda Intelligent Equipment GroupLtd (SZSE:300278), the trends above didn't look too great.

What Is 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. Analysts use this formula to calculate it for Huachangda Intelligent Equipment GroupLtd:

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

0.029 = CN¥52m ÷ (CN¥3.1b - CN¥1.4b) (Based on the trailing twelve months to September 2023).

Thus, Huachangda Intelligent Equipment GroupLtd has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.1%.

View our latest analysis for Huachangda Intelligent Equipment GroupLtd

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 Huachangda Intelligent Equipment GroupLtd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Huachangda Intelligent Equipment GroupLtd's ROCE Trending?

We are a bit anxious about the trends of ROCE at Huachangda Intelligent Equipment GroupLtd. Unfortunately, returns have declined substantially over the last five years to the 2.9% 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. 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, Huachangda Intelligent Equipment GroupLtd has done well to pay down its current liabilities to 44% of total assets. That could partly explain why the ROCE has dropped. 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. Keep in mind 44% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. It should come as no surprise then that the stock has fallen 48% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Like most companies, Huachangda Intelligent Equipment GroupLtd does come with some risks, and we've found 2 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.