If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. 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?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Deewin Tianxia is:
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).
Therefore, 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%.
Check out 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?
In terms of Deewin Tianxia's historical ROCE movements, the trend doesn't inspire confidence. About three years ago, returns on capital were 10%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Deewin Tianxia to turn into a multi-bagger.
On a side note, Deewin Tianxia has done well to pay down its current liabilities to 57% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
Our Take On Deewin Tianxia's ROCE
In summary, it's unfortunate that Deewin Tianxia is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 74% return over the last year, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
On a separate note, we've found 2 warning signs for Deewin Tianxia you'll probably want to know about.
While Deewin Tianxia 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.