Here's What's Concerning About Tiangong International's (HKG:826) Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Tiangong International (HKG:826), the trends above didn't look too great.

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

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

0.019 = CN¥13m ÷ (CN¥718m - CN¥35m) (Based on the trailing twelve months to December 2021).

Thus, Tiangong International has an ROCE of 1.9%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 14%.

See our latest analysis for Tiangong International

In the above chart we have measured Tiangong International's prior ROCE against its prior performance, but the future is arguably more important. 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

In terms of Tiangong International's historical ROCE trend, it isn't fantastic. Unfortunately, returns have declined substantially over the last five years to the 1.9% we see today. In addition to that, Tiangong International is now employing 85% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a related note, Tiangong International has decreased its current liabilities to 4.9% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 268%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Tiangong International does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is concerning...

While Tiangong 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.