To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at Xingda International Holdings (HKG:1899), so let's see why.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Xingda International Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = CN¥342m ÷ (CN¥14b - CN¥5.7b) (Based on the trailing twelve months to June 2020).
Thus, Xingda International Holdings has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 8.2%.
Above you can see how the current ROCE for Xingda International Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Xingda International Holdings, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 6.1% that they were earning five years ago. 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 Xingda International Holdings to turn into a multi-bagger.
On a side note, Xingda International Holdings' current liabilities have increased over the last five years to 42% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Bottom Line On Xingda International Holdings' ROCE
In summary, it's unfortunate that Xingda International Holdings is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 64% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One more thing, we've spotted 3 warning signs facing Xingda International Holdings that you might find interesting.
While Xingda International Holdings 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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