Capital Allocation Trends At Hangzhou Greenda Electronic Materials (SHSE:603931) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Hangzhou Greenda Electronic Materials (SHSE:603931) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Hangzhou Greenda Electronic Materials is:

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

0.10 = CN¥162m ÷ (CN¥1.7b - CN¥141m) (Based on the trailing twelve months to September 2024).

Thus, Hangzhou Greenda Electronic Materials has an ROCE of 10%. On its own, that's a standard return, however it's much better than the 5.4% generated by the Chemicals industry.

See our latest analysis for Hangzhou Greenda Electronic Materials

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Hangzhou Greenda Electronic Materials has performed in the past in other metrics, you can view this free graph of Hangzhou Greenda Electronic Materials' past earnings, revenue and cash flow.

What Does the ROCE Trend For Hangzhou Greenda Electronic Materials Tell Us?

On the surface, the trend of ROCE at Hangzhou Greenda Electronic Materials doesn't inspire confidence. To be more specific, ROCE has fallen from 21% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Hangzhou Greenda Electronic Materials has decreased its current liabilities to 8.3% of total assets. So we could link some of this to the decrease 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Hangzhou Greenda Electronic Materials' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 14% over the last three years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

While Hangzhou Greenda Electronic Materials doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation for 603931 on our platform.

While Hangzhou Greenda Electronic Materials 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.