Capital Allocation Trends At Shandong Weida Machinery (SZSE:002026) Aren't Ideal

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. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Shandong Weida Machinery (SZSE:002026), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Shandong Weida Machinery:

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

0.025 = CN¥86m ÷ (CN¥5.2b - CN¥1.8b) (Based on the trailing twelve months to September 2023).

Thus, Shandong Weida Machinery has an ROCE of 2.5%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.0%.

View our latest analysis for Shandong Weida Machinery

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Shandong Weida Machinery's past further, check out this free graph covering Shandong Weida Machinery's past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Shandong Weida Machinery doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.5% from 5.6% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 34%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 2.5%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Shandong Weida Machinery's ROCE

We're a bit apprehensive about Shandong Weida Machinery because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 36% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

If you want to continue researching Shandong Weida Machinery, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Shandong Weida Machinery may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.