Jiangsu Newamstar Packaging MachineryLtd (SZSE:300509) Could Be Struggling To Allocate Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within Jiangsu Newamstar Packaging MachineryLtd (SZSE:300509), we weren't too hopeful.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Jiangsu Newamstar Packaging MachineryLtd:

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

0.039 = CN¥28m ÷ (CN¥2.3b - CN¥1.6b) (Based on the trailing twelve months to March 2024).

So, Jiangsu Newamstar Packaging MachineryLtd has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.6%.

See our latest analysis for Jiangsu Newamstar Packaging MachineryLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Jiangsu Newamstar Packaging MachineryLtd's ROCE against it's prior returns. If you'd like to look at how Jiangsu Newamstar Packaging MachineryLtd has performed in the past in other metrics, you can view this free graph of Jiangsu Newamstar Packaging MachineryLtd's past earnings, revenue and cash flow.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Jiangsu Newamstar Packaging MachineryLtd. Unfortunately the returns on capital have diminished from the 7.0% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Jiangsu Newamstar Packaging MachineryLtd to turn into a multi-bagger.

On a side note, Jiangsu Newamstar Packaging MachineryLtd's current liabilities have increased over the last five years to 69% 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. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

In summary, it's unfortunate that Jiangsu Newamstar Packaging MachineryLtd is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 25% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One final note, you should learn about the 5 warning signs we've spotted with Jiangsu Newamstar Packaging MachineryLtd (including 2 which can't be ignored) .

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.