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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Fujian Sanmu Group (SZSE:000632), we weren't too upbeat about how things were going.
What Is 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. Analysts use this formula to calculate it for Fujian Sanmu Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.062 = CN¥198m ÷ (CN¥9.7b - CN¥6.4b) (Based on the trailing twelve months to September 2023).
Therefore, Fujian Sanmu Group has an ROCE of 6.2%. On its own, that's a low figure but it's around the 7.3% average generated by the Trade Distributors industry.
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'd like to look at how Fujian Sanmu Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
So How Is Fujian Sanmu Group's ROCE Trending?
In terms of Fujian Sanmu Group's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Fujian Sanmu Group to turn into a multi-bagger.
Another thing to note, Fujian Sanmu Group has a high ratio of current liabilities to total assets of 67%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line
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. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. 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 5 warning signs with Fujian Sanmu Group (at least 2 which don't sit too well with us) , and understanding them would certainly be useful.
While Fujian Sanmu Group 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.