Wuhan Lincontrol Automotive Electronics (SHSE:688667) May Have Issues Allocating Its Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Wuhan Lincontrol Automotive Electronics (SHSE:688667) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Wuhan Lincontrol Automotive Electronics:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.00032 = CN¥530k ÷ (CN¥2.0b - CN¥325m) (Based on the trailing twelve months to June 2024).

So, Wuhan Lincontrol Automotive Electronics has an ROCE of 0.03%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 7.2%.

View our latest analysis for Wuhan Lincontrol Automotive Electronics

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 , check out these free graphs detailing revenue and cash flow performance of Wuhan Lincontrol Automotive Electronics.

How Are Returns Trending?

When we looked at the ROCE trend at Wuhan Lincontrol Automotive Electronics, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 0.03% from 26% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Wuhan Lincontrol Automotive Electronics has decreased its current liabilities to 16% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Wuhan Lincontrol Automotive Electronics is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 64% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified 4 warning signs with Wuhan Lincontrol Automotive Electronics (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.

While Wuhan Lincontrol Automotive Electronics 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.