Dongnan ElectronicsLtd (SZSE:301359) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Dongnan ElectronicsLtd (SZSE:301359), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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 Dongnan ElectronicsLtd, this is the formula:

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

0.043 = CN¥36m ÷ (CN¥902m - CN¥56m) (Based on the trailing twelve months to September 2024).

Thus, Dongnan ElectronicsLtd has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Electrical industry average of 5.8%.

Check out our latest analysis for Dongnan ElectronicsLtd

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

What Can We Tell From Dongnan ElectronicsLtd's ROCE Trend?

On the surface, the trend of ROCE at Dongnan ElectronicsLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.3% from 25% five years ago. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Dongnan ElectronicsLtd 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 20% in the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing to note, we've identified 2 warning signs with Dongnan ElectronicsLtd and understanding them should be part of your investment process.

While Dongnan ElectronicsLtd 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.

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.