Shanghai Dragon (SHSE:600630) Has Some Difficulty Using Its Capital Effectively

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. On that note, looking into Shanghai Dragon (SHSE:600630), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Shanghai Dragon is:

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

0.0088 = CN¥8.1m ÷ (CN¥1.7b - CN¥746m) (Based on the trailing twelve months to March 2024).

So, Shanghai Dragon has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 6.5%.

See our latest analysis for Shanghai Dragon

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shanghai Dragon.

What The Trend Of ROCE Can Tell Us

We aren't inspired by the trend, given ROCE has reduced by 25% over the last five years and Shanghai Dragon is applying -50% less capital in the business, even after the capital raising they conducted (prior to their latest reported figures).

On a side note, Shanghai Dragon's current liabilities are still rather high at 45% of total assets. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

In summary, it's unfortunate that Shanghai Dragon is shrinking its capital base and also generating lower returns. Despite the concerning underlying trends, the stock has actually gained 6.9% 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.

Like most companies, Shanghai Dragon does come with some risks, and we've found 2 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.