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. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Huabao Flavours & Fragrances (SZSE:300741), so let's see why.

What Is 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. To calculate this metric for Huabao Flavours & Fragrances, this is the formula:

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

0.015 = CN¥111m ÷ (CN¥8.0b - CN¥484m) (Based on the trailing twelve months to September 2024).

So, Huabao Flavours & Fragrances has an ROCE of 1.5%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

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 Huabao Flavours & Fragrances.

What Can We Tell From Huabao Flavours & Fragrances' ROCE Trend?

There is reason to be cautious about Huabao Flavours & Fragrances, given the returns are trending downwards. About five years ago, returns on capital were 16%, 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 Huabao Flavours & Fragrances to turn into a multi-bagger.

Our Take On Huabao Flavours & Fragrances' ROCE

In summary, it's unfortunate that Huabao Flavours & Fragrances 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 18% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Huabao Flavours & Fragrances does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.