Guangdong Topstar Technology's (SZSE:300607) Returns On Capital Not Reflecting Well On The Business

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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Guangdong Topstar Technology (SZSE:300607) 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 Guangdong Topstar Technology is:

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

0.0069 = CN¥23m ÷ (CN¥6.4b - CN¥3.0b) (Based on the trailing twelve months to September 2024).

So, Guangdong Topstar Technology has an ROCE of 0.7%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.2%.

Check out our latest analysis for Guangdong Topstar Technology

Above you can see how the current ROCE for Guangdong Topstar Technology compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Guangdong Topstar Technology .

The Trend Of ROCE

When we looked at the ROCE trend at Guangdong Topstar Technology, we didn't gain much confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 0.7%. 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 separate but related note, it's important to know that Guangdong Topstar Technology has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Guangdong Topstar Technology's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Guangdong Topstar Technology have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 139% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we found 2 warning signs for Guangdong Topstar Technology (1 is potentially serious) you should be aware of.

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.