Huafon Microfibre (Shanghai) (SZSE:300180) Is Finding It Tricky To Allocate Its Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Huafon Microfibre (Shanghai) (SZSE:300180), so let's see why.

What Is Return On Capital Employed (ROCE)?

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 Huafon Microfibre (Shanghai) is:

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

0.0026 = CN¥14m ÷ (CN¥7.1b - CN¥1.9b) (Based on the trailing twelve months to September 2024).

Therefore, Huafon Microfibre (Shanghai) has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.

Check out our latest analysis for Huafon Microfibre (Shanghai)

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 Huafon Microfibre (Shanghai).

How Are Returns Trending?

There is reason to be cautious about Huafon Microfibre (Shanghai), given the returns are trending downwards. To be more specific, the ROCE was 4.7% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Huafon Microfibre (Shanghai) to turn into a multi-bagger.

Our Take On Huafon Microfibre (Shanghai)'s ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 26% 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.

If you want to continue researching Huafon Microfibre (Shanghai), you might be interested to know about the 1 warning sign that our analysis has discovered.

While Huafon Microfibre (Shanghai) 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.