Shenzhen Ruihe Construction Decoration's (SZSE:002620) Returns On Capital Tell Us There Is Reason To Feel Uneasy

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. So after glancing at the trends within Shenzhen Ruihe Construction Decoration (SZSE:002620), we weren't too hopeful.

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. Analysts use this formula to calculate it for Shenzhen Ruihe Construction Decoration:

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

0.04 = CN¥73m ÷ (CN¥4.5b - CN¥2.7b) (Based on the trailing twelve months to June 2023).

Therefore, Shenzhen Ruihe Construction Decoration has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 5.9%.

See our latest analysis for Shenzhen Ruihe Construction Decoration

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

What The Trend Of ROCE Can Tell Us

In terms of Shenzhen Ruihe Construction Decoration's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 9.3% five years ago but has since fallen to 4.0%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 23% over that same period. 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. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a separate but related note, it's important to know that Shenzhen Ruihe Construction Decoration has a current liabilities to total assets ratio of 60%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Shenzhen Ruihe Construction Decoration's ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. It should come as no surprise then that the stock has fallen 54% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Shenzhen Ruihe Construction Decoration does come with some risks though, we found 3 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.