Chongqing Sifang New Material (SHSE:605122) May Have Issues Allocating Its 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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Chongqing Sifang New Material (SHSE:605122) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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. Analysts use this formula to calculate it for Chongqing Sifang New Material:

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

0.025 = CN¥62m ÷ (CN¥4.2b - CN¥1.6b) (Based on the trailing twelve months to September 2024).

Therefore, Chongqing Sifang New Material has an ROCE of 2.5%. Ultimately, that's a low return and it under-performs the Basic Materials industry average of 5.7%.

View our latest analysis for Chongqing Sifang New Material

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chongqing Sifang New Material'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 Chongqing Sifang New Material.

What Can We Tell From Chongqing Sifang New Material's ROCE Trend?

When we looked at the ROCE trend at Chongqing Sifang New Material, we didn't gain much confidence. Around five years ago the returns on capital were 33%, but since then they've fallen to 2.5%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Chongqing Sifang New Material has decreased its current liabilities to 39% 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 Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Chongqing Sifang New Material have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 52% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to know some of the risks facing Chongqing Sifang New Material we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.