Harbin Air ConditioningLtd's (SHSE:600202) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at Harbin Air ConditioningLtd (SHSE:600202), so let's see why.

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Understanding 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. The formula for this calculation on Harbin Air ConditioningLtd is:

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

0.062 = CN¥61m ÷ (CN¥3.0b - CN¥2.0b) (Based on the trailing twelve months to September 2024).

Therefore, Harbin Air ConditioningLtd has an ROCE of 6.2%. In absolute terms, that's a low return and it also under-performs the Building industry average of 7.8%.

See our latest analysis for Harbin Air ConditioningLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Harbin Air ConditioningLtd's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Harbin Air ConditioningLtd.

So How Is Harbin Air ConditioningLtd's ROCE Trending?

We are a bit worried about the trend of returns on capital at Harbin Air ConditioningLtd. Unfortunately the returns on capital have diminished from the 10% that they were earning five years ago. 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 Harbin Air ConditioningLtd becoming one if things continue as they have.

On a side note, Harbin Air ConditioningLtd's current liabilities have increased over the last five years to 67% 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. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

In Conclusion...

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Despite the concerning underlying trends, the stock has actually gained 34% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a final note, we found 2 warning signs for Harbin Air ConditioningLtd (1 is a bit unpleasant) you should be aware of.

While Harbin Air ConditioningLtd 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.