What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Shanghai Electric Group (HKG:2727), we weren't too hopeful.
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 Electric Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.02 = CN¥2.3b ÷ (CN¥290b - CN¥177b) (Based on the trailing twelve months to September 2024).
So, Shanghai Electric Group has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.3%.
See our latest analysis for Shanghai Electric Group
Above you can see how the current ROCE for Shanghai Electric Group 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 analyst report for Shanghai Electric Group .
What Can We Tell From Shanghai Electric Group's ROCE Trend?
There is reason to be cautious about Shanghai Electric Group, given the returns are trending downwards. About five years ago, returns on capital were 4.6%, however they're now substantially lower than that as we saw above. 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 Shanghai Electric Group to turn into a multi-bagger.
On a separate but related note, it's important to know that Shanghai Electric Group has a current liabilities to total assets ratio of 61%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Key Takeaway
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors must expect better things on the horizon though because the stock has risen 37% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
If you're still interested in Shanghai Electric Group it's worth checking out our FREE intrinsic value approximation for 2727 to see if it's trading at an attractive price in other respects.
While Shanghai Electric Group 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.