China Literature (HKG:772) Will Be Hoping To Turn Its Returns On Capital Around

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. In light of that, when we looked at China Literature (HKG:772) and its ROCE trend, we weren't exactly thrilled.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for China Literature, this is the formula:

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

0.025 = CN¥468m ÷ (CN¥23b - CN¥4.0b) (Based on the trailing twelve months to December 2022).

Thus, China Literature has an ROCE of 2.5%. Ultimately, that's a low return and it under-performs the Media industry average of 6.5%.

View our latest analysis for China Literature

In the above chart we have measured China Literature's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Literature.

So How Is China Literature's ROCE Trending?

On the surface, the trend of ROCE at China Literature doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.5% from 3.6% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

The Bottom Line

In summary, we're somewhat concerned by China Literature's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 42% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing, we've spotted 1 warning sign facing China Literature that you might find interesting.

While China Literature may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.