If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. 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 Shanghai CarthaneLtd (SHSE:603037), we weren't too upbeat about how things were going.
Understanding Return On Capital Employed (ROCE)
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 Shanghai CarthaneLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = CN¥48m ÷ (CN¥1.0b - CN¥156m) (Based on the trailing twelve months to June 2023).
Thus, Shanghai CarthaneLtd has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Auto Components industry average of 5.7%.
Check out our latest analysis for Shanghai CarthaneLtd
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 Shanghai CarthaneLtd, check out these free graphs here.
What Can We Tell From Shanghai CarthaneLtd's ROCE Trend?
In terms of Shanghai CarthaneLtd's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 17%, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Shanghai CarthaneLtd becoming one if things continue as they have.
In Conclusion...
In summary, it's unfortunate that Shanghai CarthaneLtd is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 83% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you'd like to know more about Shanghai CarthaneLtd, we've spotted 4 warning signs, and 1 of them can't be ignored.
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.