Returns On Capital Signal Difficult Times Ahead For Fanli Digital TechnologyLtd (SHSE:600228)

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Fanli Digital TechnologyLtd (SHSE:600228), we weren't too hopeful.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Fanli Digital TechnologyLtd, this is the formula:

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

0.013 = CN¥7.1m ÷ (CN¥697m - CN¥166m) (Based on the trailing twelve months to September 2023).

Thus, Fanli Digital TechnologyLtd has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Interactive Media and Services industry average of 5.5%.

See our latest analysis for Fanli Digital TechnologyLtd

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 Fanli Digital TechnologyLtd.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Fanli Digital TechnologyLtd. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. 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 Fanli Digital TechnologyLtd becoming one if things continue as they have.

On a related note, Fanli Digital TechnologyLtd has decreased its current liabilities to 24% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Fanli Digital TechnologyLtd's ROCE

In summary, it's unfortunate that Fanli Digital TechnologyLtd is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last year have experienced a 52% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we found 2 warning signs for Fanli Digital TechnologyLtd (1 shouldn't be ignored) you should be aware of.

While Fanli Digital TechnologyLtd 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.