Some Investors May Be Worried About China Literature's (HKG:772) Returns On Capital
To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. And from a first read, things don't look too good at China Literature (HKG:772), so let's see why.
Understanding 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 China Literature is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = CN¥515m ÷ (CN¥23b - CN¥3.7b) (Based on the trailing twelve months to June 2025).
Thus, China Literature has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Media industry average of 6.3%.
Check out our latest analysis for China Literature
In the above chart we have measured China Literature's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for China Literature .
What Does the ROCE Trend For China Literature Tell Us?
We are a bit worried about the trend of returns on capital at China Literature. To be more specific, the ROCE was 3.8% 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 China Literature to turn into a multi-bagger.
In Conclusion...
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. Investors haven't taken kindly to these developments, since the stock has declined 47% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing to note, we've identified 2 warning signs with China Literature and understanding these should be part of your investment process.
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.