Shanghai Rychen Technologies (SZSE:301273) May Have Issues Allocating Its Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Shanghai Rychen Technologies (SZSE:301273) 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?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Shanghai Rychen Technologies, this is the formula:

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

0.0039 = CN¥4.1m ÷ (CN¥1.3b - CN¥192m) (Based on the trailing twelve months to September 2023).

Thus, Shanghai Rychen Technologies has an ROCE of 0.4%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.0%.

View our latest analysis for Shanghai Rychen Technologies

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shanghai Rychen Technologies' ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shanghai Rychen Technologies.

So How Is Shanghai Rychen Technologies' ROCE Trending?

In terms of Shanghai Rychen Technologies' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 23% over the last four years. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Shanghai Rychen Technologies has done well to pay down its current liabilities to 15% 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. 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 Shanghai Rychen Technologies' ROCE

In summary, we're somewhat concerned by Shanghai Rychen Technologies' diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 60% from where it was year ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Shanghai Rychen Technologies does have some risks, we noticed 4 warning signs (and 2 which don't sit too well with us) we think you should know about.

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.

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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.