China ITS (Holdings) (HKG:1900) Has Some Difficulty Using Its Capital Effectively

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, China ITS (Holdings) (HKG:1900) we aren't filled with optimism, but let's investigate further.

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 China ITS (Holdings), this is the formula:

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

0.018 = CN¥34m ÷ (CN¥3.5b - CN¥1.6b) (Based on the trailing twelve months to December 2020).

So, China ITS (Holdings) has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the IT industry average of 7.6%.

See our latest analysis for China ITS (Holdings)

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

What Does the ROCE Trend For China ITS (Holdings) Tell Us?

The trend of ROCE at China ITS (Holdings) is showing some signs of weakness. The company used to generate 2.7% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 22% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a related note, China ITS (Holdings) has decreased its current liabilities to 46% 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. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Unsurprisingly then, the stock has dived 74% over the last five years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing, we've spotted 2 warning signs facing China ITS (Holdings) that you might find interesting.

While China ITS (Holdings) 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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