Returns On Capital Signal Tricky Times Ahead For Zhejiang XinchaiLtd (SZSE:301032)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Zhejiang XinchaiLtd (SZSE:301032) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Zhejiang XinchaiLtd, this is the formula:

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

0.055 = CN¥66m ÷ (CN¥2.6b - CN¥1.4b) (Based on the trailing twelve months to September 2024).

Therefore, Zhejiang XinchaiLtd has an ROCE of 5.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.2%.

See our latest analysis for Zhejiang XinchaiLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang XinchaiLtd's ROCE against it's prior returns. If you're interested in investigating Zhejiang XinchaiLtd's past further, check out this free graph covering Zhejiang XinchaiLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Zhejiang XinchaiLtd doesn't inspire confidence. Around five years ago the returns on capital were 9.0%, but since then they've fallen to 5.5%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Zhejiang XinchaiLtd has decreased its current liabilities to 54% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 54% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

In summary, Zhejiang XinchaiLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last three years, the stock has given away 25% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Zhejiang XinchaiLtd has the makings of a multi-bagger.

On a final note, we've found 3 warning signs for Zhejiang XinchaiLtd that we think you should be aware of.

While Zhejiang XinchaiLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.