Hunan Zhongke Electric (SZSE:300035) 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? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at Hunan Zhongke Electric (SZSE:300035), it didn't seem to tick all of these boxes.

What Is 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. To calculate this metric for Hunan Zhongke Electric, this is the formula:

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

0.064 = CN¥458m ÷ (CN¥11b - CN¥4.3b) (Based on the trailing twelve months to September 2024).

Therefore, Hunan Zhongke Electric has an ROCE of 6.4%. On its own that's a low return, but compared to the average of 5.2% generated by the Machinery industry, it's much better.

Check out our latest analysis for Hunan Zhongke Electric

Above you can see how the current ROCE for Hunan Zhongke Electric 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 Hunan Zhongke Electric for free.

The Trend Of ROCE

When we looked at the ROCE trend at Hunan Zhongke Electric, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 6.4%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Hunan Zhongke Electric's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 113% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One final note, you should learn about the 3 warning signs we've spotted with Hunan Zhongke Electric (including 1 which makes us a bit uncomfortable) .

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.