China Steel (TWSE:2002) Could Be Struggling To Allocate Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within China Steel (TWSE:2002), we weren't too hopeful.

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. The formula for this calculation on China Steel is:

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

0.0068 = NT$3.5b ÷ (NT$679b - NT$168b) (Based on the trailing twelve months to December 2023).

So, China Steel has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 7.1%.

See our latest analysis for China Steel

Above you can see how the current ROCE for China Steel compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for China Steel .

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at China Steel. About five years ago, returns on capital were 6.8%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 China Steel becoming one if things continue as they have.

What We Can Learn From China Steel's ROCE

In summary, it's unfortunate that China Steel is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 22% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for China Steel (of which 1 shouldn't be ignored!) that you should know about.

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.