Capital Allocation Trends At Freewon ChinaLtd (SHSE:688678) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Freewon ChinaLtd (SHSE:688678) 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. To calculate this metric for Freewon ChinaLtd, this is the formula:

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

0.016 = CN¥40m ÷ (CN¥3.5b - CN¥966m) (Based on the trailing twelve months to December 2024).

Thus, Freewon ChinaLtd has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Machinery industry average of 5.2%.

Check out our latest analysis for Freewon ChinaLtd

In the above chart we have measured Freewon ChinaLtd'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 Freewon ChinaLtd .

What Can We Tell From Freewon ChinaLtd's ROCE Trend?

On the surface, the trend of ROCE at Freewon ChinaLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.6% from 24% 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Freewon ChinaLtd is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 89% over the last three years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing to note, we've identified 3 warning signs with Freewon ChinaLtd and understanding them should be part of your investment process.

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.