When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. On that note, looking into SanFeng Intelligent Equipment Group (SZSE:300276), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on SanFeng Intelligent Equipment Group is:

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

0.0025 = CN¥5.0m ÷ (CN¥4.7b - CN¥2.7b) (Based on the trailing twelve months to March 2024).

Thus, SanFeng Intelligent Equipment Group has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.6%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for SanFeng Intelligent Equipment Group's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of SanFeng Intelligent Equipment Group.

How Are Returns Trending?

We are a bit anxious about the trends of ROCE at SanFeng Intelligent Equipment Group. The company used to generate 8.5% on its capital five years ago but it has since fallen noticeably. What's equally concerning is that the amount of capital deployed in the business has shrunk by 46% 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. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 58%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 0.3%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

In Conclusion...

In summary, it's unfortunate that SanFeng Intelligent Equipment Group is shrinking its capital base and also generating lower returns. It should come as no surprise then that the stock has fallen 29% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing to note, we've identified 1 warning sign with SanFeng Intelligent Equipment Group and understanding this should be part of your investment process.

While SanFeng Intelligent Equipment Group 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.