Shanghai Kelai Mechatronics EngineeringLtd (SHSE:603960) 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? 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. Although, when we looked at Shanghai Kelai Mechatronics EngineeringLtd (SHSE:603960), it didn't seem to tick all of these boxes.

Understanding 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. To calculate this metric for Shanghai Kelai Mechatronics EngineeringLtd, this is the formula:

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

0.075 = CN¥78m ÷ (CN¥1.2b - CN¥199m) (Based on the trailing twelve months to September 2023).

So, Shanghai Kelai Mechatronics EngineeringLtd has an ROCE of 7.5%. On its own that's a low return, but compared to the average of 6.0% generated by the Machinery industry, it's much better.

View our latest analysis for Shanghai Kelai Mechatronics EngineeringLtd

In the above chart we have measured Shanghai Kelai Mechatronics EngineeringLtd'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 Shanghai Kelai Mechatronics EngineeringLtd .

What Can We Tell From Shanghai Kelai Mechatronics EngineeringLtd's ROCE Trend?

On the surface, the trend of ROCE at Shanghai Kelai Mechatronics EngineeringLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.5% from 15% 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 side note, Shanghai Kelai Mechatronics EngineeringLtd has done well to pay down its current liabilities to 16% 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. 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 On Shanghai Kelai Mechatronics EngineeringLtd's ROCE

While returns have fallen for Shanghai Kelai Mechatronics EngineeringLtd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 59% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing, we've spotted 1 warning sign facing Shanghai Kelai Mechatronics EngineeringLtd that you might find interesting.

While Shanghai Kelai Mechatronics EngineeringLtd 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.