Gulf Resources (NASDAQ:GURE) Could Be At Risk Of Shrinking As A Company

When researching a stock for investment, what can tell us that the company is 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 indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within Gulf Resources (NASDAQ:GURE), we weren't too hopeful.

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. The formula for this calculation on Gulf Resources is:

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

0.043 = US$13m ÷ (US$338m - US$39m) (Based on the trailing twelve months to March 2022).

Therefore, Gulf Resources has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 12%.

Check out our latest analysis for Gulf Resources

Historical performance is a great place to start when researching a stock so above you can see the gauge for Gulf Resources' ROCE against it's prior returns. If you're interested in investigating Gulf Resources' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Gulf Resources' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 14% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Gulf Resources to turn into a multi-bagger.

What We Can Learn From Gulf Resources' ROCE

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. Long term shareholders who've owned the stock over the last five years have experienced a 44% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 2 warning signs with Gulf Resources and understanding them should be part of your investment process.

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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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.