Zhejiang Sanfer Electric (SHSE:605336) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Zhejiang Sanfer Electric (SHSE:605336), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Zhejiang Sanfer Electric, this is the formula:

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

0.037 = CN¥70m ÷ (CN¥2.2b - CN¥325m) (Based on the trailing twelve months to June 2024).

So, Zhejiang Sanfer Electric has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 8.8%.

View our latest analysis for Zhejiang Sanfer Electric

Above you can see how the current ROCE for Zhejiang Sanfer Electric compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Zhejiang Sanfer Electric .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Zhejiang Sanfer Electric, we didn't gain much confidence. To be more specific, ROCE has fallen from 26% over the last five years. 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 Sanfer Electric has decreased its current liabilities to 15% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Zhejiang Sanfer Electric's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Sanfer Electric have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 36% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with Zhejiang Sanfer Electric and understanding this should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.