If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into SINOMACH HEAVY EQUIPMENT GROUPLTD (SHSE:601399), we weren't too upbeat about how things were going.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for SINOMACH HEAVY EQUIPMENT GROUPLTD:

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

0.018 = CN¥317m ÷ (CN¥31b - CN¥13b) (Based on the trailing twelve months to March 2024).

Thus, SINOMACH HEAVY EQUIPMENT GROUPLTD has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.6%.

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of SINOMACH HEAVY EQUIPMENT GROUPLTD.

What Can We Tell From SINOMACH HEAVY EQUIPMENT GROUPLTD's ROCE Trend?

We are a bit worried about the trend of returns on capital at SINOMACH HEAVY EQUIPMENT GROUPLTD. Unfortunately the returns on capital have diminished from the 3.8% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 SINOMACH HEAVY EQUIPMENT GROUPLTD becoming one if things continue as they have.

On a side note, SINOMACH HEAVY EQUIPMENT GROUPLTD's current liabilities are still rather high at 41% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In summary, it's unfortunate that SINOMACH HEAVY EQUIPMENT GROUPLTD is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 29% over the last three 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.

If you're still interested in SINOMACH HEAVY EQUIPMENT GROUPLTD it's worth checking out our FREE intrinsic value approximation for 601399 to see if it's trading at an attractive price in other respects.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.