Returns On Capital Signal Tricky Times Ahead For Kunshan Dongwei TechnologyLtd (SHSE:688700)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Kunshan Dongwei TechnologyLtd (SHSE:688700) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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 Kunshan Dongwei TechnologyLtd, this is the formula:

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

0.063 = CN¥113m ÷ (CN¥2.4b - CN¥565m) (Based on the trailing twelve months to March 2024).

Therefore, Kunshan Dongwei TechnologyLtd has an ROCE of 6.3%. Even though it's in line with the industry average of 5.6%, it's still a low return by itself.

See 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.

What Does the ROCE Trend For Kunshan Dongwei TechnologyLtd Tell Us?

In terms of Kunshan Dongwei TechnologyLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 36%, but since then they've fallen to 6.3%. 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 side note, Kunshan Dongwei TechnologyLtd has done well to pay down its current liabilities to 24% 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 Key Takeaway

In summary, we're somewhat concerned by Kunshan Dongwei TechnologyLtd's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 36% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, 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 is a bit concerning...

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.