Chengdu Tianjian Technology (SZSE:002977) May Have Issues Allocating Its Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Chengdu Tianjian Technology (SZSE:002977) 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)

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. The formula for this calculation on Chengdu Tianjian Technology is:

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

0.07 = CN¥77m ÷ (CN¥1.4b - CN¥274m) (Based on the trailing twelve months to September 2023).

So, Chengdu Tianjian Technology has an ROCE of 7.0%. On its own that's a low return, but compared to the average of 5.4% generated by the Aerospace & Defense industry, it's much better.

See our latest analysis for Chengdu Tianjian Technology

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'd like to look at how Chengdu Tianjian Technology has performed in the past in other metrics, you can view this free graph of Chengdu Tianjian Technology's past earnings, revenue and cash flow.

What Does the ROCE Trend For Chengdu Tianjian Technology Tell Us?

In terms of Chengdu Tianjian Technology's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.0% from 33% five years ago. 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, Chengdu Tianjian Technology has decreased its current liabilities to 20% 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 Chengdu Tianjian Technology's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 61% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Chengdu Tianjian Technology does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored...

While Chengdu Tianjian Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.