Be Wary Of Zhejiang Semir Garment (SZSE:002563) And Its Returns On Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within Zhejiang Semir Garment (SZSE:002563), we weren't too hopeful.

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. The formula for this calculation on Zhejiang Semir Garment is:

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

0.12 = CN¥1.4b ÷ (CN¥18b - CN¥6.1b) (Based on the trailing twelve months to March 2024).

Thus, Zhejiang Semir Garment has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 6.5% it's much better.

See our latest analysis for Zhejiang Semir Garment

Above you can see how the current ROCE for Zhejiang Semir Garment compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Zhejiang Semir Garment for free.

What Can We Tell From Zhejiang Semir Garment's ROCE Trend?

There is reason to be cautious about Zhejiang Semir Garment, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 17% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Zhejiang Semir Garment becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 34%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On Zhejiang Semir Garment's ROCE

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. It should come as no surprise then that the stock has fallen 22% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we've found 1 warning sign for Zhejiang Semir Garment that we think you should be aware of.

While Zhejiang Semir Garment 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.