If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after glancing at the trends within Changmao Biochemical Engineering (HKG:954), we weren't too hopeful.
What is Return On Capital Employed (ROCE)?
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 Changmao Biochemical Engineering, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = CN¥21m ÷ (CN¥847m - CN¥196m) (Based on the trailing twelve months to December 2020).
Thus, Changmao Biochemical Engineering has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 9.5%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Changmao Biochemical Engineering's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Changmao Biochemical Engineering, check out these free graphs here.
The Trend Of ROCE
There is reason to be cautious about Changmao Biochemical Engineering, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 7.6% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Changmao Biochemical Engineering to turn into a multi-bagger.
In summary, it's unfortunate that Changmao Biochemical Engineering is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 29% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Like most companies, Changmao Biochemical Engineering does come with some risks, and we've found 3 warning signs that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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