If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Tongding Interconnection Information (SZSE:002491) we aren't filled with optimism, but let's investigate further.
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 Tongding Interconnection Information, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = CN¥257m ÷ (CN¥6.1b - CN¥3.5b) (Based on the trailing twelve months to June 2023).
Thus, Tongding Interconnection Information has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Communications industry average of 5.4% it's much better.
Check out our latest analysis for Tongding Interconnection Information
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 want to delve into the historical earnings, revenue and cash flow of Tongding Interconnection Information, check out these free graphs here.
What Can We Tell From Tongding Interconnection Information's ROCE Trend?
The trend of ROCE at Tongding Interconnection Information is showing some signs of weakness. The company used to generate 14% on its capital five years ago but it has since fallen noticeably. What's equally concerning is that the amount of capital deployed in the business has shrunk by 54% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a side note, Tongding Interconnection Information's current liabilities have increased over the last five years to 58% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
The Bottom Line
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 27% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a final note, we found 2 warning signs for Tongding Interconnection Information (1 is concerning) you should be aware of.
While Tongding Interconnection Information 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.