Shanghai Yaoji Technology (SZSE:002605) Is Reinvesting At Lower Rates Of Return

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Shanghai Yaoji Technology (SZSE:002605), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Shanghai Yaoji Technology:

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

0.15 = CN¥624m ÷ (CN¥4.9b - CN¥820m) (Based on the trailing twelve months to September 2024).

Thus, Shanghai Yaoji Technology has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 5.3% generated by the Leisure industry.

View our latest analysis for Shanghai Yaoji Technology

In the above chart we have measured Shanghai Yaoji Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanghai Yaoji Technology for free.

The Trend Of ROCE

When we looked at the ROCE trend at Shanghai Yaoji Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 15% from 27% five years ago. 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 side note, Shanghai Yaoji Technology has done well to pay down its current liabilities to 17% 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.

What We Can Learn From Shanghai Yaoji Technology's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Shanghai Yaoji Technology have fallen, meanwhile the business is employing more capital than it was five years ago. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 68% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

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

While Shanghai Yaoji Technology 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.