Capital Allocation Trends At Shanghai XFH Technology (SZSE:300890) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Shanghai XFH Technology (SZSE:300890), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Shanghai XFH Technology is:

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

0.031 = CN¥97m ÷ (CN¥4.3b - CN¥1.2b) (Based on the trailing twelve months to September 2024).

Thus, Shanghai XFH Technology has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Electrical industry average of 5.8%.

See our latest analysis for Shanghai XFH Technology

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shanghai XFH Technology.

What The Trend Of ROCE Can Tell Us

In terms of Shanghai XFH Technology's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 related note, Shanghai XFH Technology has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

In summary, we're somewhat concerned by Shanghai XFH Technology's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 60% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 5 warning signs for Shanghai XFH Technology (1 can't be ignored) you should be aware of.

While Shanghai XFH Technology 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.