Zhejiang Hongchang Electrical Technology (SZSE:301008) May Have Issues Allocating Its Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Zhejiang Hongchang Electrical Technology (SZSE:301008) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhejiang Hongchang Electrical Technology, this is the formula:

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

0.062 = CN¥92m ÷ (CN¥2.0b - CN¥498m) (Based on the trailing twelve months to March 2024).

So, Zhejiang Hongchang Electrical Technology has an ROCE of 6.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.0%.

See our latest analysis for Zhejiang Hongchang Electrical 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 Zhejiang Hongchang Electrical Technology's past further, check out this free graph covering Zhejiang Hongchang Electrical Technology's past earnings, revenue and cash flow.

So How Is Zhejiang Hongchang Electrical Technology's ROCE Trending?

In terms of Zhejiang Hongchang Electrical Technology's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 19%, but since then they've fallen to 6.2%. 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, Zhejiang Hongchang Electrical Technology has done well to pay down its current liabilities to 25% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Zhejiang Hongchang Electrical Technology's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Zhejiang Hongchang Electrical Technology is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 25% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Zhejiang Hongchang Electrical Technology does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are significant...

While Zhejiang Hongchang Electrical 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com