There Are Reasons To Feel Uneasy About Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's (SZSE:000523) Returns On 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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou (SZSE:000523) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou:

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

0.039 = CN¥110m ÷ (CN¥3.5b - CN¥596m) (Based on the trailing twelve months to September 2024).

So, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou has an ROCE of 3.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 3.8%.

View our latest analysis for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou

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

How Are Returns Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 11% five years ago, while the business's capital employed increased by 38%. That being said, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a related note, Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou has decreased its current liabilities to 17% of total assets. Since the ratio used to be 72%, that's a significant reduction and it no doubt explains the drop 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.

Our Take On Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 40% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we've found 1 warning sign for Hongmian Zhihui Science and Technology InnovationLtd.Guangzhou that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.