Here's What's Concerning About Shanxi Meijin EnergyLtd's (SZSE:000723) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Shanxi Meijin EnergyLtd (SZSE:000723) and its ROCE trend, we weren't exactly thrilled.

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

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. To calculate this metric for Shanxi Meijin EnergyLtd, this is the formula:

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

0.069 = CN¥1.7b ÷ (CN¥40b - CN¥16b) (Based on the trailing twelve months to September 2023).

So, Shanxi Meijin EnergyLtd has an ROCE of 6.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.9%.

See our latest analysis for Shanxi Meijin EnergyLtd

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shanxi Meijin EnergyLtd.

What Does the ROCE Trend For Shanxi Meijin EnergyLtd Tell Us?

In terms of Shanxi Meijin EnergyLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.9% from 27% five years ago. 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, Shanxi Meijin EnergyLtd has decreased its current liabilities to 40% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Shanxi Meijin EnergyLtd's ROCE

We're a bit apprehensive about Shanxi Meijin EnergyLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last five years have experienced a 60% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know more about Shanxi Meijin EnergyLtd, we've spotted 2 warning signs, and 1 of them shouldn't be ignored.

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.