Xiamen East Asia Machinery Industrial (SZSE:301028) Could Be Struggling To Allocate Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Xiamen East Asia Machinery Industrial (SZSE:301028), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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. To calculate this metric for Xiamen East Asia Machinery Industrial, this is the formula:

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

0.12 = CN¥171m ÷ (CN¥2.0b - CN¥552m) (Based on the trailing twelve months to March 2024).

Thus, Xiamen East Asia Machinery Industrial has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 5.6% it's much better.

Check out our latest analysis for Xiamen East Asia Machinery Industrial

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 Xiamen East Asia Machinery Industrial's past further, check out this free graph covering Xiamen East Asia Machinery Industrial's past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Xiamen East Asia Machinery Industrial's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 22%, but since then they've fallen to 12%. 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, Xiamen East Asia Machinery Industrial has done well to pay down its current liabilities to 28% of total assets. That could partly explain why the ROCE has dropped. 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.

The Bottom Line On Xiamen East Asia Machinery Industrial's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Xiamen East Asia Machinery Industrial is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 29% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Like most companies, Xiamen East Asia Machinery Industrial does come with some risks, and we've found 1 warning sign that you should be aware of.

While Xiamen East Asia Machinery Industrial 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