Be Wary Of Shenglong Splendecor International (HKG:8481) And Its Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Shenglong Splendecor International (HKG:8481) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Shenglong Splendecor International, this is the formula:

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

0.054 = CN¥14m ÷ (CN¥555m - CN¥288m) (Based on the trailing twelve months to June 2022).

So, Shenglong Splendecor International has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 8.1%.

View our latest analysis for Shenglong Splendecor International

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenglong Splendecor International's ROCE against it's prior returns. If you're interested in investigating Shenglong Splendecor International's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Shenglong Splendecor International doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.4% from 27% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Shenglong Splendecor International has decreased its current liabilities to 52% of total assets. That could partly explain why the ROCE has dropped. 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. Keep in mind 52% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Shenglong Splendecor International's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 65% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Shenglong Splendecor International (including 2 which are a bit unpleasant) .

While Shenglong Splendecor International 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.