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. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. 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, Leon Technology (SZSE:300603) we aren't filled with optimism, but let's investigate further.

What Is 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 Leon Technology:

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

0.011 = CN¥16m ÷ (CN¥2.2b - CN¥728m) (Based on the trailing twelve months to September 2024).

Thus, Leon Technology has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the IT industry average of 3.8%.

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 Leon Technology.

What Does the ROCE Trend For Leon Technology Tell Us?

We are a bit anxious about the trends of ROCE at Leon Technology. To be more specific, today's ROCE was 5.4% five years ago but has since fallen to 1.1%. On top of that, the business is utilizing 40% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

The Bottom Line

To see Leon Technology reducing the capital employed in the business in tandem with diminishing returns, is concerning. It should come as no surprise then that the stock has fallen 23% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a separate note, we've found 1 warning sign for Leon Technology you'll probably want to know about.

While Leon Technology 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.