When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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 the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Henan Qingshuiyuan TechnologyLtd (SZSE:300437), so let's see why.

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 Henan Qingshuiyuan TechnologyLtd is:

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

0.03 = CN¥56m ÷ (CN¥2.9b - CN¥1.1b) (Based on the trailing twelve months to March 2023).

Thus, Henan Qingshuiyuan TechnologyLtd has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 7.1%.

See our latest analysis for Henan Qingshuiyuan TechnologyLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Henan Qingshuiyuan TechnologyLtd's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Henan Qingshuiyuan TechnologyLtd Tell Us?

There is reason to be cautious about Henan Qingshuiyuan TechnologyLtd, given the returns are trending downwards. About five years ago, returns on capital were 12%, 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. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Henan Qingshuiyuan TechnologyLtd becoming one if things continue as they have.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 10.0% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing: We've identified 2 warning signs with Henan Qingshuiyuan TechnologyLtd (at least 1 which can't be ignored) , and understanding these would certainly be useful.

While Henan Qingshuiyuan TechnologyLtd 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.