If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Global Infotech (SZSE:300465), we weren't too hopeful.

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. To calculate this metric for Global Infotech, this is the formula:

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

0.053 = CN¥36m ÷ (CN¥1.3b - CN¥662m) (Based on the trailing twelve months to September 2024).

Therefore, Global Infotech has an ROCE of 5.3%. On its own that's a low return, but compared to the average of 2.3% generated by the Software industry, it's much better.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Global Infotech's ROCE against it's prior returns. If you'd like to look at how Global Infotech has performed in the past in other metrics, you can view this free graph of Global Infotech's past earnings, revenue and cash flow.

What Can We Tell From Global Infotech's ROCE Trend?

The trend of ROCE at Global Infotech is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 5.3% we see today. On top of that, the business is utilizing 57% 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. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Global Infotech's current liabilities have increased over the last five years to 49% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

Our Take On Global Infotech's ROCE

To see Global Infotech reducing the capital employed in the business in tandem with diminishing returns, is concerning. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 128%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

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

While Global Infotech 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.