Shanghai General Healthy Information and Technology (SHSE:605186) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Shanghai General Healthy Information and Technology (SHSE:605186) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Shanghai General Healthy Information and Technology:

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

0.062 = CN¥71m ÷ (CN¥1.3b - CN¥148m) (Based on the trailing twelve months to September 2023).

Thus, Shanghai General Healthy Information and Technology has an ROCE of 6.2%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 9.1%.

View our latest analysis for Shanghai General Healthy Information and Technology

Above you can see how the current ROCE for Shanghai General Healthy Information and Technology 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 Shanghai General Healthy Information and Technology for free.

The Trend Of ROCE

When we looked at the ROCE trend at Shanghai General Healthy Information and Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 39% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Shanghai General Healthy Information and Technology has done well to pay down its current liabilities to 11% 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. 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 Shanghai General Healthy Information and Technology's diminishing returns on increasing amounts of capital. However the stock has delivered a 77% return to shareholders over the last three years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a separate note, we've found 1 warning sign for Shanghai General Healthy Information and Technology you'll probably want to know about.

While Shanghai General Healthy Information 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.