There Are Reasons To Feel Uneasy About Xinfengming Group's (SHSE:603225) Returns On Capital

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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Xinfengming Group (SHSE:603225), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Xinfengming Group is:

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

0.059 = CN¥1.6b ÷ (CN¥55b - CN¥28b) (Based on the trailing twelve months to June 2024).

Thus, Xinfengming Group has an ROCE of 5.9%. Even though it's in line with the industry average of 5.5%, it's still a low return by itself.

View our latest analysis for Xinfengming Group

In the above chart we have measured Xinfengming Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Xinfengming Group .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Xinfengming Group doesn't inspire confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 5.9%. 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, Xinfengming Group's current liabilities have increased over the last five years to 50% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

Our Take On Xinfengming Group's ROCE

While returns have fallen for Xinfengming Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 13% in the last five years. 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 Xinfengming Group (of which 1 doesn't sit too well with us!) that you should know about.

While Xinfengming Group 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.