Zhejiang Linuo Flow Control TechnologyLtd (SZSE:300838) Could Be Struggling To Allocate 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. 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. However, after briefly looking over the numbers, we don't think Zhejiang Linuo Flow Control TechnologyLtd (SZSE:300838) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Zhejiang Linuo Flow Control TechnologyLtd:

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

0.13 = CN¥128m ÷ (CN¥1.5b - CN¥459m) (Based on the trailing twelve months to September 2023).

Thus, Zhejiang Linuo Flow Control TechnologyLtd has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 6.0% it's much better.

View our latest analysis for Zhejiang Linuo Flow Control TechnologyLtd

Above you can see how the current ROCE for Zhejiang Linuo Flow Control TechnologyLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Zhejiang Linuo Flow Control TechnologyLtd .

How Are Returns Trending?

In terms of Zhejiang Linuo Flow Control TechnologyLtd's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 21% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Zhejiang Linuo Flow Control TechnologyLtd has done well to pay down its current liabilities to 31% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Zhejiang Linuo Flow Control TechnologyLtd's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Zhejiang Linuo Flow Control TechnologyLtd. These growth trends haven't led to growth returns though, since the stock has fallen 28% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a final note, we've found 1 warning sign for Zhejiang Linuo Flow Control TechnologyLtd that we think you should be aware of.

While Zhejiang Linuo Flow Control TechnologyLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.