Shenzhen Honor Electronic's (SZSE:300870) Returns On Capital Not Reflecting Well On The Business

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Shenzhen Honor Electronic (SZSE:300870), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Shenzhen Honor Electronic, this is the formula:

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

0.08 = CN¥233m ÷ (CN¥5.1b - CN¥2.2b) (Based on the trailing twelve months to September 2024).

Therefore, Shenzhen Honor Electronic has an ROCE of 8.0%. In absolute terms, that's a low return, but it's much better than the Electrical industry average of 5.9%.

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'd like, you can check out the forecasts from the analysts covering Shenzhen Honor Electronic for free.

What Can We Tell From Shenzhen Honor Electronic's ROCE Trend?

In terms of Shenzhen Honor Electronic's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 23% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Shenzhen Honor Electronic has done well to pay down its current liabilities to 43% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From Shenzhen Honor Electronic'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 Shenzhen Honor Electronic. And long term investors must be optimistic going forward because the stock has returned a huge 222% to shareholders in the last three years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you'd like to know about the risks facing Shenzhen Honor Electronic, we've discovered 1 warning sign that 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.