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. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Huabao Flavours & Fragrances (SZSE:300741) we aren't filled with optimism, but let's investigate further.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Huabao Flavours & Fragrances:

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

0.034 = CN¥259m ÷ (CN¥8.2b - CN¥541m) (Based on the trailing twelve months to March 2024).

So, Huabao Flavours & Fragrances has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Huabao Flavours & Fragrances' ROCE against it's prior returns. If you'd like to look at how Huabao Flavours & Fragrances has performed in the past in other metrics, you can view this free graph of Huabao Flavours & Fragrances' past earnings, revenue and cash flow.

What Does the ROCE Trend For Huabao Flavours & Fragrances Tell Us?

There is reason to be cautious about Huabao Flavours & Fragrances, given the returns are trending downwards. To be more specific, the ROCE was 12% 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 Huabao Flavours & Fragrances to turn into a multi-bagger.

The Bottom Line On Huabao Flavours & Fragrances' 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. Long term shareholders who've owned the stock over the last five years have experienced a 36% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Huabao Flavours & Fragrances does have some risks, we noticed 3 warning signs (and 2 which are a bit concerning) we think you should know about.

While Huabao Flavours & Fragrances 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.

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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.

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