Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. In light of that, from a first glance at Sunwave CommunicationsLtd (SZSE:002115), we've spotted some signs that it could be struggling, so let's investigate.

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. To calculate this metric for Sunwave CommunicationsLtd, this is the formula:

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

0.015 = CN¥39m ÷ (CN¥4.5b - CN¥1.9b) (Based on the trailing twelve months to September 2024).

So, Sunwave CommunicationsLtd has an ROCE of 1.5%. Ultimately, that's a low return and it under-performs the Media industry average of 5.2%.

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're interested in investigating Sunwave CommunicationsLtd's past further, check out this free graph covering Sunwave CommunicationsLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Sunwave CommunicationsLtd's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 6.3%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Sunwave CommunicationsLtd becoming one if things continue as they have.

Another thing to note, Sunwave CommunicationsLtd has a high ratio of current liabilities to total assets of 41%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Sunwave CommunicationsLtd's ROCE

In summary, it's unfortunate that Sunwave CommunicationsLtd is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 36% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with Sunwave CommunicationsLtd and understanding it should be part of your investment process.

While Sunwave CommunicationsLtd 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.