Some Investors May Be Worried About Zhejiang Lianxiang Smart Home's (SHSE:603272) 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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 Lianxiang Smart Home (SHSE:603272) 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. To calculate this metric for Zhejiang Lianxiang Smart Home, this is the formula:

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

0.016 = CN¥10.0m ÷ (CN¥714m - CN¥74m) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Lianxiang Smart Home has an ROCE of 1.6%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 8.1%.

See our latest analysis for Zhejiang Lianxiang Smart Home

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang Lianxiang Smart Home's 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 Zhejiang Lianxiang Smart Home.

How Are Returns Trending?

When we looked at the ROCE trend at Zhejiang Lianxiang Smart Home, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 1.6% from 46% four years ago. 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, Zhejiang Lianxiang Smart Home has done well to pay down its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. 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. 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.

Our Take On Zhejiang Lianxiang Smart Home's ROCE

In summary, we're somewhat concerned by Zhejiang Lianxiang Smart Home's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last year have experienced a 37% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Zhejiang Lianxiang Smart Home (including 1 which is a bit unpleasant) .

While Zhejiang Lianxiang Smart Home isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.