Capital Allocation Trends At Wuxi Sunlit Science and Technology (HKG:1289) Aren't Ideal

What underlying fundamental trends can indicate that a company might be in decline? 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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Wuxi Sunlit Science and Technology (HKG:1289), we weren't too hopeful.

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 Wuxi Sunlit Science and Technology, this is the formula:

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

0.019 = CN¥12m ÷ (CN¥946m - CN¥291m) (Based on the trailing twelve months to December 2022).

So, Wuxi Sunlit Science and Technology has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Machinery industry average of 7.0%.

See our latest analysis for Wuxi Sunlit Science and Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for Wuxi Sunlit Science and Technology's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Wuxi Sunlit Science and Technology, check out these free graphs here.

How Are Returns Trending?

There is reason to be cautious about Wuxi Sunlit Science and Technology, given the returns are trending downwards. To be more specific, the ROCE was 4.0% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Wuxi Sunlit Science and Technology to turn into a multi-bagger.

On a side note, Wuxi Sunlit Science and Technology's current liabilities have increased over the last five years to 31% 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. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

In Conclusion...

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 53% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Wuxi Sunlit Science and Technology (of which 1 is concerning!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.