There Are Reasons To Feel Uneasy About Guangdong Topstar Technology's (SZSE:300607) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Guangdong Topstar Technology (SZSE:300607), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Guangdong Topstar Technology:

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).

Therefore, 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 5.3%.

Check out our latest analysis for Guangdong Topstar Technology

In the above chart we have measured Guangdong Topstar Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Guangdong Topstar Technology for free.

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%. 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.

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 can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On 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. Yet despite these concerning fundamentals, the stock has performed strongly with a 62% return over the last five years, so investors appear very optimistic. 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 separate note, we've found 1 warning sign for Guangdong Topstar Technology you'll probably want to know about.

While Guangdong Topstar 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.