There Are Reasons To Feel Uneasy About Zhejiang Extek Technology's (SZSE:301399) Returns On Capital

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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Zhejiang Extek Technology (SZSE:301399), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhejiang Extek Technology, this is the formula:

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

0.045 = CN¥61m ÷ (CN¥1.5b - CN¥109m) (Based on the trailing twelve months to September 2024).

So, Zhejiang Extek Technology has an ROCE of 4.5%. On its own, that's a low figure but it's around the 5.2% average generated by the Machinery industry.

View our latest analysis for Zhejiang Extek Technology

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're interested in investigating Zhejiang Extek Technology's past further, check out this free graph covering Zhejiang Extek Technology's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Zhejiang Extek Technology, we didn't gain much confidence. Around five years ago the returns on capital were 34%, but since then they've fallen to 4.5%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Zhejiang Extek Technology has decreased its current liabilities to 7.4% of total assets. That could partly explain why the ROCE has dropped. 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 Zhejiang Extek Technology's ROCE

In summary, we're somewhat concerned by Zhejiang Extek Technology's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 33% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Zhejiang Extek Technology does have some risks though, and we've spotted 2 warning signs for Zhejiang Extek Technology that you might be interested in.

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.