Chengdu Qushui Science and Technology (SZSE:301336) Could Be Struggling To Allocate 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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. In light of that, when we looked at Chengdu Qushui Science and Technology (SZSE:301336) and its ROCE trend, we weren't exactly thrilled.

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 Chengdu Qushui Science and Technology, this is the formula:

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

0.013 = CN¥11m ÷ (CN¥858m - CN¥65m) (Based on the trailing twelve months to September 2023).

So, Chengdu Qushui Science and Technology has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 8.3%.

View our latest analysis for Chengdu Qushui Science and Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chengdu Qushui Science and Technology'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 Chengdu Qushui Science and Technology.

What Does the ROCE Trend For Chengdu Qushui Science and Technology Tell Us?

When we looked at the ROCE trend at Chengdu Qushui Science and Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 20% over the last five years. 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 related note, Chengdu Qushui Science and Technology has decreased its current liabilities to 7.6% of total assets. So we could link some of this to the decrease in ROCE. 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.

In Conclusion...

In summary, we're somewhat concerned by Chengdu Qushui Science and Technology's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 39% from where it was year ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 4 warning signs for Chengdu Qushui Science and Technology (2 can't be ignored) you should be aware of.

While Chengdu Qushui Science and Technology may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.