Shenzhen Honor Electronic (SZSE:300870) May Have Issues Allocating Its Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Shenzhen Honor Electronic (SZSE:300870) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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 Shenzhen Honor Electronic is:

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

0.047 = CN¥100m ÷ (CN¥3.7b - CN¥1.6b) (Based on the trailing twelve months to September 2023).

Therefore, Shenzhen Honor Electronic has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.5%.

See our latest analysis for Shenzhen Honor Electronic

Above you can see how the current ROCE for Shenzhen Honor Electronic 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 Shenzhen Honor Electronic .

So How Is Shenzhen Honor Electronic's ROCE Trending?

On the surface, the trend of ROCE at Shenzhen Honor Electronic doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 4.7%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Shenzhen Honor Electronic has decreased its current liabilities to 43% of total assets. That could partly explain why the ROCE has dropped. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

To conclude, we've found that Shenzhen Honor Electronic is reinvesting in the business, but returns have been falling. And in the last three years, the stock has given away 32% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a final note, we found 2 warning signs for Shenzhen Honor Electronic (1 is potentially serious) you should be aware of.

While Shenzhen Honor Electronic 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.