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. And from a first read, things don't look too good at Shanghai Stonehill Technology (SZSE:002195), so let's see why.

Understanding Return On Capital Employed (ROCE)

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 Shanghai Stonehill Technology:

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

0.0046 = CN¥45m ÷ (CN¥10b - CN¥206m) (Based on the trailing twelve months to March 2024).

Therefore, Shanghai Stonehill Technology has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Software industry average of 3.0%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shanghai Stonehill Technology'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 Shanghai Stonehill Technology.

What Does the ROCE Trend For Shanghai Stonehill Technology Tell Us?

In terms of Shanghai Stonehill Technology's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 18% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Shanghai Stonehill Technology becoming one if things continue as they have.

On a side note, Shanghai Stonehill Technology has done well to pay down its current liabilities to 2.0% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Shanghai Stonehill Technology's ROCE

In summary, it's unfortunate that Shanghai Stonehill Technology is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 24% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing, we've spotted 1 warning sign facing Shanghai Stonehill Technology that you might find interesting.

While Shanghai Stonehill Technology 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com