Capital Allocation Trends At Keystone Electrical (Zhejiang)Ltd (SZSE:301448) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at Keystone Electrical (Zhejiang)Ltd (SZSE:301448) 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)

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 Keystone Electrical (Zhejiang)Ltd, this is the formula:

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

0.069 = CN¥48m ÷ (CN¥823m - CN¥129m) (Based on the trailing twelve months to March 2024).

Thus, Keystone Electrical (Zhejiang)Ltd has an ROCE of 6.9%. In absolute terms, that's a low return but it's around the Consumer Durables industry average of 8.4%.

See our latest analysis for Keystone Electrical (Zhejiang)Ltd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Keystone Electrical (Zhejiang)Ltd'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 Keystone Electrical (Zhejiang)Ltd.

What Does the ROCE Trend For Keystone Electrical (Zhejiang)Ltd Tell Us?

When we looked at the ROCE trend at Keystone Electrical (Zhejiang)Ltd, we didn't gain much confidence. To be more specific, ROCE has fallen from 24% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Keystone Electrical (Zhejiang)Ltd has done well to pay down its current liabilities to 16% 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.

The Bottom Line On Keystone Electrical (Zhejiang)Ltd's ROCE

While returns have fallen for Keystone Electrical (Zhejiang)Ltd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Keystone Electrical (Zhejiang)Ltd (of which 1 is a bit unpleasant!) that you should know about.

While Keystone Electrical (Zhejiang)Ltd 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com