Zhejiang Yaguang TechnologyLtd's (SHSE:603282) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Zhejiang Yaguang TechnologyLtd (SHSE:603282) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Zhejiang Yaguang TechnologyLtd is:

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

0.089 = CN¥114m ÷ (CN¥2.8b - CN¥1.6b) (Based on the trailing twelve months to September 2024).

Thus, Zhejiang Yaguang TechnologyLtd has an ROCE of 8.9%. On its own that's a low return, but compared to the average of 5.2% generated by the Machinery industry, it's much better.

View our latest analysis for Zhejiang Yaguang 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 Zhejiang Yaguang TechnologyLtd.

What Does the ROCE Trend For Zhejiang Yaguang TechnologyLtd Tell Us?

On the surface, the trend of ROCE at Zhejiang Yaguang TechnologyLtd doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 8.9%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Zhejiang Yaguang TechnologyLtd has decreased its current liabilities to 55% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 55% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Yaguang TechnologyLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last year have experienced a 39% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we've found 1 warning sign for Zhejiang Yaguang TechnologyLtd that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.