Changzhou Xiangming Intelligent Drive System's (SZSE:301226) Returns On Capital Not Reflecting Well On The Business

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Changzhou Xiangming Intelligent Drive System (SZSE:301226), 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 Changzhou Xiangming Intelligent Drive System:

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

0.027 = CN¥25m ÷ (CN¥1.0b - CN¥114m) (Based on the trailing twelve months to March 2024).

So, Changzhou Xiangming Intelligent Drive System has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.0%.

View our latest analysis for Changzhou Xiangming Intelligent Drive System

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 Changzhou Xiangming Intelligent Drive System has performed in the past in other metrics, you can view this free graph of Changzhou Xiangming Intelligent Drive System's past earnings, revenue and cash flow.

What Does the ROCE Trend For Changzhou Xiangming Intelligent Drive System Tell Us?

When we looked at the ROCE trend at Changzhou Xiangming Intelligent Drive System, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last five years. 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 side note, Changzhou Xiangming Intelligent Drive System has done well to pay down its current liabilities to 11% 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.

What We Can Learn From Changzhou Xiangming Intelligent Drive System's ROCE

In summary, we're somewhat concerned by Changzhou Xiangming Intelligent Drive System's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last year have experienced a 40% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to know some of the risks facing Changzhou Xiangming Intelligent Drive System we've found 4 warning signs (1 is significant!) that you should be aware of before investing here.

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.