To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. So after we looked into Gem-Year IndustrialLtd (SHSE:601002), the trends above didn't look too great.

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. The formula for this calculation on Gem-Year IndustrialLtd is:

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

0.022 = CN¥93m ÷ (CN¥5.2b - CN¥983m) (Based on the trailing twelve months to September 2024).

Thus, Gem-Year IndustrialLtd has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Machinery 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'd like to look at how Gem-Year IndustrialLtd has performed in the past in other metrics, you can view this free graph of Gem-Year IndustrialLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Gem-Year IndustrialLtd. About five years ago, returns on capital were 7.4%, 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. 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. If these trends continue, we wouldn't expect Gem-Year IndustrialLtd to turn into a multi-bagger.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know more about Gem-Year IndustrialLtd, we've spotted 2 warning signs, and 1 of them is significant.

While Gem-Year IndustrialLtd 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.