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. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into Shanghai Industrial Holdings (HKG:363), the trends above didn't look too great.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shanghai Industrial Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = HK$6.1b ÷ (HK$178b - HK$53b) (Based on the trailing twelve months to June 2023).
Thus, Shanghai Industrial Holdings has an ROCE of 4.9%. In absolute terms, that's a low return, but it's much better than the Industrials industry average of 2.5%.
View our latest analysis for Shanghai Industrial Holdings
Above you can see how the current ROCE for Shanghai Industrial Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Shanghai Industrial Holdings' ROCE Trend?
In terms of Shanghai Industrial Holdings' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 7.2% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Shanghai Industrial Holdings to turn into a multi-bagger.
What We Can Learn From Shanghai Industrial Holdings' ROCE
In summary, it's unfortunate that Shanghai Industrial Holdings is generating lower returns from the same amount of capital. And long term shareholders have watched their investments stay flat over the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing: We've identified 2 warning signs with Shanghai Industrial Holdings (at least 1 which is significant) , and understanding these would certainly be useful.
While Shanghai Industrial Holdings 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.