Zhejiang Sanfer Electric (SHSE:605336) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Zhejiang Sanfer Electric (SHSE:605336), we don't think it's current trends fit the mold of a multi-bagger.

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 Sanfer Electric, this is the formula:

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

0.083 = CN¥162m ÷ (CN¥2.2b - CN¥282m) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Sanfer Electric has an ROCE of 8.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.1%.

See 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'd like, you can check out the forecasts from the analysts covering Zhejiang Sanfer Electric for free.

So How Is Zhejiang Sanfer Electric's ROCE Trending?

In terms of Zhejiang Sanfer Electric's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 8.3% from 35% five 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 Sanfer Electric has done well to pay down its current liabilities to 13% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On 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. Investors haven't taken kindly to these developments, since the stock has declined 31% from where it was three years ago. 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.

While Zhejiang Sanfer Electric 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.