Shanghai Mechanical & Electrical IndustryLtd (SHSE:600835) May Have Issues Allocating Its Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Shanghai Mechanical & Electrical IndustryLtd (SHSE:600835) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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 Mechanical & Electrical IndustryLtd is:

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

0.065 = CN¥1.1b ÷ (CN¥37b - CN¥21b) (Based on the trailing twelve months to December 2023).

Thus, Shanghai Mechanical & Electrical IndustryLtd has an ROCE of 6.5%. On its own, that's a low figure but it's around the 6.1% average generated by the Machinery industry.

Check out our latest analysis for Shanghai Mechanical & Electrical IndustryLtd

In the above chart we have measured Shanghai Mechanical & Electrical IndustryLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Shanghai Mechanical & Electrical IndustryLtd .

What Can We Tell From Shanghai Mechanical & Electrical IndustryLtd's ROCE Trend?

On the surface, the trend of ROCE at Shanghai Mechanical & Electrical IndustryLtd doesn't inspire confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 6.5%. However it looks like Shanghai Mechanical & Electrical IndustryLtd might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, Shanghai Mechanical & Electrical IndustryLtd has a high ratio of current liabilities to total assets of 55%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Shanghai Mechanical & Electrical IndustryLtd's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 21% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing, we've spotted 1 warning sign facing Shanghai Mechanical & Electrical IndustryLtd that you might find interesting.

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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.