Foshan Electrical and LightingLtd (SZSE:000541) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Foshan Electrical and LightingLtd (SZSE:000541), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Foshan Electrical and LightingLtd:

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

0.02 = CN¥207m ÷ (CN¥17b - CN¥6.8b) (Based on the trailing twelve months to September 2024).

Thus, Foshan Electrical and LightingLtd has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 5.9%.

View our latest analysis for Foshan Electrical and LightingLtd

In the above chart we have measured Foshan Electrical and LightingLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Foshan Electrical and LightingLtd .

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 4.6% five years ago, while capital employed has grown 137%. Usually this isn't ideal, but given Foshan Electrical and LightingLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Foshan Electrical and LightingLtd's earnings and if they change as a result from the capital raise.

On a side note, Foshan Electrical and LightingLtd's current liabilities have increased over the last five years to 39% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

In Conclusion...

In summary, Foshan Electrical and LightingLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 42% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Foshan Electrical and LightingLtd does have some risks though, and we've spotted 2 warning signs for Foshan Electrical and LightingLtd that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.