Capital Allocation Trends At Shanghai Stonehill Technology (SZSE:002195) Aren't Ideal

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. 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 Shanghai Stonehill Technology (SZSE:002195), so let's see why.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Shanghai Stonehill Technology, this is the formula:

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

0.0027 = CN¥26m ÷ (CN¥9.9b - CN¥263m) (Based on the trailing twelve months to September 2023).

Thus, Shanghai Stonehill Technology has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the Software industry average of 2.7%.

Check out our latest analysis for Shanghai Stonehill Technology

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

What The Trend Of ROCE Can Tell Us

In terms of Shanghai Stonehill Technology's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 9.6% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Shanghai Stonehill Technology to turn into a multi-bagger.

On a related note, Shanghai Stonehill Technology has decreased its current liabilities to 2.6% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Shanghai Stonehill Technology's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 39% 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Shanghai Stonehill Technology (of which 1 doesn't sit too well with us!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.