Some Investors May Be Worried About Zhejiang Chang'an Renheng Technology's (HKG:8139) Returns On Capital

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. In light of that, from a first glance at Zhejiang Chang'an Renheng Technology (HKG:8139), we've spotted some signs that it could be struggling, so let's investigate.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Zhejiang Chang'an Renheng Technology is:

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

0.026 = CN¥3.0m ÷ (CN¥279m - CN¥164m) (Based on the trailing twelve months to September 2022).

So, Zhejiang Chang'an Renheng Technology has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 15%.

Check out our latest analysis for Zhejiang Chang'an Renheng Technology

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

What Can We Tell From Zhejiang Chang'an Renheng Technology's ROCE Trend?

We are a bit worried about the trend of returns on capital at Zhejiang Chang'an Renheng Technology. To be more specific, the ROCE was 5.0% 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. 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 Chang'an Renheng Technology to turn into a multi-bagger.

On a side note, Zhejiang Chang'an Renheng Technology's current liabilities have increased over the last five years to 59% 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.

What We Can Learn From Zhejiang Chang'an Renheng 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. Investors haven't taken kindly to these developments, since the stock has declined 70% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to continue researching Zhejiang Chang'an Renheng Technology, you might be interested to know about the 2 warning signs that our analysis has discovered.

While Zhejiang Chang'an Renheng 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.