Zhejiang TongLi Transmission Technology (SZSE:301255) Is Reinvesting At Lower Rates Of Return

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 TongLi Transmission Technology (SZSE:301255) 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)

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. The formula for this calculation on Zhejiang TongLi Transmission Technology is:

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

0.051 = CN¥54m ÷ (CN¥1.4b - CN¥290m) (Based on the trailing twelve months to September 2024).

Therefore, Zhejiang TongLi Transmission Technology has an ROCE of 5.1%. Even though it's in line with the industry average of 5.3%, it's still a low return by itself.

Check out our latest analysis for Zhejiang TongLi Transmission Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang TongLi Transmission Technology's ROCE against it's prior returns. If you'd like to look at how Zhejiang TongLi Transmission Technology has performed in the past in other metrics, you can view this free graph of Zhejiang TongLi Transmission Technology's past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Zhejiang TongLi Transmission Technology's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.1% from 19% five years ago. However it looks like Zhejiang TongLi Transmission Technology might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Zhejiang TongLi Transmission Technology has decreased its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. 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 Key Takeaway

In summary, Zhejiang TongLi Transmission Technology is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 63% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 3 warning signs we've spotted with Zhejiang TongLi Transmission Technology (including 1 which is significant) .

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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

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.