Here's What's Concerning About China Automotive Systems' (NASDAQ:CAAS) Returns On Capital

What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base 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 China Automotive Systems (NASDAQ:CAAS), we weren't too upbeat about how things were going.

What Is 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. The formula for this calculation on China Automotive Systems is:

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

0.034 = US$12m ÷ (US$675m - US$335m) (Based on the trailing twelve months to September 2022).

So, China Automotive Systems has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 13%.

View our latest analysis for China Automotive Systems

Above you can see how the current ROCE for China Automotive Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Automotive Systems here for free.

How Are Returns Trending?

There is reason to be cautious about China Automotive Systems, given the returns are trending downwards. To be more specific, the ROCE was 7.6% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect China Automotive Systems to turn into a multi-bagger.

Another thing to note, China Automotive Systems has a high ratio of current liabilities to total assets of 50%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From China Automotive Systems' ROCE

In summary, it's unfortunate that China Automotive Systems is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 40% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you'd like to know more about China Automotive Systems, we've spotted 2 warning signs, and 1 of them is significant.

While China Automotive Systems 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.