If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Zhejiang Ming Jewelry (SZSE:002574), so let's see why.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Zhejiang Ming Jewelry is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = CN¥41m ÷ (CN¥6.2b - CN¥3.1b) (Based on the trailing twelve months to September 2023).
Thus, Zhejiang Ming Jewelry has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Luxury industry average of 5.1%.
See our latest analysis for Zhejiang Ming Jewelry
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 Zhejiang Ming Jewelry, check out these free graphs here.
What Can We Tell From Zhejiang Ming Jewelry's ROCE Trend?
There is reason to be cautious about Zhejiang Ming Jewelry, given the returns are trending downwards. About five years ago, returns on capital were 2.5%, 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. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Zhejiang Ming Jewelry becoming one if things continue as they have.
On a side note, Zhejiang Ming Jewelry's current liabilities have increased over the last five years to 49% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 1.3%. 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.
What We Can Learn From Zhejiang Ming Jewelry's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Despite the concerning underlying trends, the stock has actually gained 17% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Like most companies, Zhejiang Ming Jewelry does come with some risks, and we've found 1 warning sign that you should be aware of.
While Zhejiang Ming Jewelry 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.