Capital Allocation Trends At Deewin Tianxia (HKG:2418) Aren't Ideal

When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Deewin Tianxia (HKG:2418), we weren't too upbeat about how things were going.

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 Deewin Tianxia, this is the formula:

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

0.073 = CN¥274m ÷ (CN¥8.8b - CN¥5.0b) (Based on the trailing twelve months to June 2023).

Thus, Deewin Tianxia has an ROCE of 7.3%. In absolute terms, that's a low return, but it's much better than the Transportation industry average of 4.8%.

View our latest analysis for Deewin Tianxia

Historical performance is a great place to start when researching a stock so above you can see the gauge for Deewin Tianxia's ROCE against it's prior returns. If you'd like to look at how Deewin Tianxia has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Deewin Tianxia Tell Us?

There is reason to be cautious about Deewin Tianxia, given the returns are trending downwards. About three years ago, returns on capital were 10%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Deewin Tianxia becoming one if things continue as they have.

On a side note, Deewin Tianxia has done well to pay down its current liabilities to 57% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 57% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

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. Yet despite these poor fundamentals, the stock has gained a huge 171% over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we've found 2 warning signs for Deewin Tianxia that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.