Zhejiang Tengy Environmental Technology's (HKG:1527) Returns On Capital Tell Us There Is Reason To Feel Uneasy

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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. On that note, looking into Zhejiang Tengy Environmental Technology (HKG:1527), we weren't too upbeat about how things were going.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Zhejiang Tengy Environmental Technology is:

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

0.067 = CN¥53m ÷ (CN¥1.5b - CN¥703m) (Based on the trailing twelve months to June 2022).

So, Zhejiang Tengy Environmental Technology has an ROCE of 6.7%. Even though it's in line with the industry average of 7.0%, it's still a low return by itself.

Check out our latest analysis for Zhejiang Tengy Environmental Technology

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

How Are Returns Trending?

There is reason to be cautious about Zhejiang Tengy Environmental Technology, given the returns are trending downwards. About five years ago, returns on capital were 13%, 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Zhejiang Tengy Environmental Technology to turn into a multi-bagger.

On a side note, Zhejiang Tengy Environmental Technology's current liabilities are still rather high at 47% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. We expect this has contributed to the stock plummeting 74% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to know some of the risks facing Zhejiang Tengy Environmental Technology we've found 3 warning signs (1 can't be ignored!) that you should be aware of before investing here.

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.