Brilliance Technology (SZSE:300542) Could Be Struggling To Allocate Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Brilliance Technology (SZSE:300542), we weren't too upbeat about how things were going.

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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 Brilliance Technology is:

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

0.068 = CN¥44m ÷ (CN¥1.4b - CN¥798m) (Based on the trailing twelve months to September 2024).

Thus, Brilliance Technology has an ROCE of 6.8%. On its own that's a low return, but compared to the average of 3.7% generated by the IT industry, it's much better.

View our latest analysis for Brilliance Technology

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

What Can We Tell From Brilliance Technology's ROCE Trend?

We are a bit worried about the trend of returns on capital at Brilliance Technology. About five years ago, returns on capital were 9.0%, however they're now substantially lower than that as we saw above. 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 Brilliance Technology to turn into a multi-bagger.

On a side note, Brilliance Technology's current liabilities have increased over the last five years to 56% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 6.8%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

What We Can Learn From Brilliance Technology'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. Yet despite these concerning fundamentals, the stock has performed strongly with a 68% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Brilliance Technology (of which 1 is a bit concerning!) that you should know about.

While Brilliance Technology 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.