Zhejiang Zhaolong Interconnect TechnologyLtd (SZSE:300913) Could Be Struggling To Allocate Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Zhejiang Zhaolong Interconnect TechnologyLtd (SZSE:300913) 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. Analysts use this formula to calculate it for Zhejiang Zhaolong Interconnect TechnologyLtd:

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

0.059 = CN¥66m ÷ (CN¥1.3b - CN¥156m) (Based on the trailing twelve months to March 2024).

Thus, Zhejiang Zhaolong Interconnect TechnologyLtd has an ROCE of 5.9%. Even though it's in line with the industry average of 6.0%, it's still a low return by itself.

View our latest analysis for Zhejiang Zhaolong Interconnect TechnologyLtd

In the above chart we have measured Zhejiang Zhaolong Interconnect TechnologyLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Zhejiang Zhaolong Interconnect TechnologyLtd .

How Are Returns Trending?

We weren't thrilled with the trend because Zhejiang Zhaolong Interconnect TechnologyLtd's ROCE has reduced by 78% over the last five years, while the business employed 268% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Zhejiang Zhaolong Interconnect TechnologyLtd might not have received a full period of earnings contribution from it.

On a related note, Zhejiang Zhaolong Interconnect TechnologyLtd has decreased its current liabilities to 12% 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 Zhejiang Zhaolong Interconnect TechnologyLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Zhejiang Zhaolong Interconnect TechnologyLtd's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 260% return in the last three years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to continue researching Zhejiang Zhaolong Interconnect TechnologyLtd, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Zhejiang Zhaolong Interconnect TechnologyLtd 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.