Zhejiang Mustang BatteryLtd (SHSE:605378) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. In light of that, when we looked at Zhejiang Mustang BatteryLtd (SHSE:605378) and its ROCE trend, we weren't exactly thrilled.

What Is 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 Zhejiang Mustang BatteryLtd:

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

0.063 = CN¥77m ÷ (CN¥1.4b - CN¥232m) (Based on the trailing twelve months to June 2023).

Therefore, Zhejiang Mustang BatteryLtd has an ROCE of 6.3%. On its own that's a low return, but compared to the average of 4.6% generated by the Household Products industry, it's much better.

See our latest analysis for Zhejiang Mustang BatteryLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang Mustang BatteryLtd's ROCE against it's prior returns. If you'd like to look at how Zhejiang Mustang BatteryLtd has performed in the past in other metrics, you can view this free graph of Zhejiang Mustang BatteryLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Zhejiang Mustang BatteryLtd, we didn't gain much confidence. To be more specific, ROCE has fallen from 24% 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 related note, Zhejiang Mustang BatteryLtd has decreased its current liabilities to 16% 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. 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...

From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Mustang BatteryLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 15% return over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Zhejiang Mustang BatteryLtd (of which 1 is significant!) that you should know about.

While Zhejiang Mustang BatteryLtd 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.