When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Shenzhen Sunline Tech (SZSE:300348) we aren't filled with optimism, but let's investigate further.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shenzhen Sunline Tech, this is the formula:

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

0.038 = CN¥61m ÷ (CN¥2.5b - CN¥878m) (Based on the trailing twelve months to September 2023).

Therefore, Shenzhen Sunline Tech has an ROCE of 3.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.0%.

Above you can see how the current ROCE for Shenzhen Sunline Tech 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 Shenzhen Sunline Tech here for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Shenzhen Sunline Tech, given the returns are trending downwards. About five years ago, returns on capital were 6.0%, 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 Sunline Tech becoming one if things continue as they have.

On a side note, Shenzhen Sunline Tech's current liabilities have increased over the last five years to 35% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 3.8%. 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.

The Bottom Line On Shenzhen Sunline Tech's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Shenzhen Sunline Tech does have some risks though, and we've spotted 2 warning signs for Shenzhen Sunline Tech that you might be interested in.

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.

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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.