Returns On Capital Signal Tricky Times Ahead For Shanghai XFH Technology (SZSE:300890)

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Shanghai XFH Technology (SZSE:300890), it didn't seem to tick all of these boxes.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.034 = CN¥100m ÷ (CN¥4.2b - CN¥1.2b) (Based on the trailing twelve months to March 2024).

Therefore, Shanghai XFH Technology has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Electrical industry average of 6.0%.

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'd like to look at how Shanghai XFH Technology has performed in the past in other metrics, you can view this free graph of Shanghai XFH Technology's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Shanghai XFH Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.4% from 11% five years ago. 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 29% 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. 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 Bottom Line On Shanghai XFH Technology's ROCE

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 47% 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.

Shanghai XFH Technology does have some risks, we noticed 5 warning signs (and 2 which shouldn't be ignored) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.