Shanghai Zhongchen Electronic TechnologyLtd (SHSE:603275) Could Be Struggling To Allocate Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Shanghai Zhongchen Electronic TechnologyLtd (SHSE:603275) and its ROCE trend, we weren't exactly thrilled.

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 Shanghai Zhongchen Electronic TechnologyLtd:

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

0.065 = CN¥179m ÷ (CN¥3.0b - CN¥278m) (Based on the trailing twelve months to June 2024).

Therefore, Shanghai Zhongchen Electronic TechnologyLtd has an ROCE of 6.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.9%.

Check out our latest analysis for Shanghai Zhongchen Electronic TechnologyLtd

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 Shanghai Zhongchen Electronic TechnologyLtd.

The Trend Of ROCE

On the surface, the trend of ROCE at Shanghai Zhongchen Electronic TechnologyLtd doesn't inspire confidence. To be more specific, ROCE has fallen from 50% over the last four years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Shanghai Zhongchen Electronic TechnologyLtd has decreased its current liabilities to 9.2% 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Shanghai Zhongchen Electronic TechnologyLtd's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 34% in the last year. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a separate note, we've found 1 warning sign for Shanghai Zhongchen Electronic TechnologyLtd you'll probably want to know about.

While Shanghai Zhongchen Electronic TechnologyLtd 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.