Be Wary Of Shenzhen Strongteam Decoration Engineering (SZSE:002989) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Shenzhen Strongteam Decoration Engineering (SZSE:002989), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Shenzhen Strongteam Decoration Engineering, this is the formula:

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

0.027 = CN¥60m ÷ (CN¥3.2b - CN¥956m) (Based on the trailing twelve months to September 2023).

Therefore, Shenzhen Strongteam Decoration Engineering has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 5.5%.

See our latest analysis for Shenzhen Strongteam Decoration Engineering

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

So How Is Shenzhen Strongteam Decoration Engineering's ROCE Trending?

In terms of Shenzhen Strongteam Decoration Engineering's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.7% from 23% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Shenzhen Strongteam Decoration Engineering has decreased its current liabilities to 30% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Shenzhen Strongteam Decoration Engineering's ROCE

In summary, we're somewhat concerned by Shenzhen Strongteam Decoration Engineering's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 64% over the last three 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.

One more thing: We've identified 4 warning signs with Shenzhen Strongteam Decoration Engineering (at least 1 which is significant) , and understanding them would certainly be useful.

While Shenzhen Strongteam Decoration Engineering isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.