Foshan Electrical and LightingLtd (SZSE:000541) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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 Foshan Electrical and LightingLtd (SZSE:000541) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on Foshan Electrical and LightingLtd is:

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

0.024 = CN¥253m ÷ (CN¥17b - CN¥6.3b) (Based on the trailing twelve months to March 2024).

Therefore, Foshan Electrical and LightingLtd has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.0%.

See our latest analysis for Foshan Electrical and LightingLtd

Above you can see how the current ROCE for Foshan Electrical and LightingLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Foshan Electrical and LightingLtd for free.

What Can We Tell From Foshan Electrical and LightingLtd's ROCE Trend?

We weren't thrilled with the trend because Foshan Electrical and LightingLtd's ROCE has reduced by 63% over the last five years, while the business employed 119% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Foshan Electrical and LightingLtd might not have received a full period of earnings contribution from it.

On a side note, Foshan Electrical and LightingLtd's current liabilities have increased over the last five years to 38% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.4%. 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.

Our Take On Foshan Electrical and LightingLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Foshan Electrical and LightingLtd's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 4.3% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

Like most companies, Foshan Electrical and LightingLtd does come with some risks, and we've found 3 warning signs that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com