Investors Could Be Concerned With Shanghai XFH Technology's (SZSE:300890) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Shanghai XFH Technology (SZSE:300890) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Shanghai XFH Technology:

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).

Therefore, 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%.

Check out 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're interested in investigating Shanghai XFH Technology's past further, check out this free graph covering Shanghai XFH Technology's past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Shanghai XFH Technology doesn't inspire confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 3.1%. 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 side note, Shanghai XFH Technology has done well to pay down its current liabilities to 27% 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.

What We Can Learn From Shanghai XFH Technology's ROCE

In summary, we're somewhat concerned by Shanghai XFH Technology's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 36% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to know some of the risks facing Shanghai XFH Technology we've found 4 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

While Shanghai XFH 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.