Kunshan Dongwei TechnologyLtd (SHSE:688700) May Have Issues Allocating Its Capital

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 Kunshan Dongwei TechnologyLtd (SHSE:688700) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Kunshan Dongwei TechnologyLtd is:

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

0.026 = CN¥46m ÷ (CN¥2.5b - CN¥730m) (Based on the trailing twelve months to September 2024).

So, Kunshan Dongwei TechnologyLtd has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Machinery industry average of 5.2%.

View our latest analysis for Kunshan Dongwei TechnologyLtd

In the above chart we have measured Kunshan Dongwei TechnologyLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Kunshan Dongwei TechnologyLtd for free.

So How Is Kunshan Dongwei TechnologyLtd's ROCE Trending?

On the surface, the trend of ROCE at Kunshan Dongwei TechnologyLtd doesn't inspire confidence. To be more specific, ROCE has fallen from 28% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Kunshan Dongwei TechnologyLtd has decreased its current liabilities to 29% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Kunshan Dongwei TechnologyLtd's ROCE

We're a bit apprehensive about Kunshan Dongwei TechnologyLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 11% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Kunshan Dongwei TechnologyLtd does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

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.