Capital Allocation Trends At Fanli Digital TechnologyLtd (SHSE:600228) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. However, after investigating Fanli Digital TechnologyLtd (SHSE:600228), we don't think it's current trends fit the mold of a multi-bagger.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Fanli Digital TechnologyLtd, this is the formula:

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

0.023 = CN¥34m ÷ (CN¥1.6b - CN¥131m) (Based on the trailing twelve months to March 2024).

Therefore, Fanli Digital TechnologyLtd has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Interactive Media and Services industry average of 5.3%.

View our latest analysis for Fanli Digital TechnologyLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Fanli Digital TechnologyLtd's ROCE against it's prior returns. If you're interested in investigating Fanli Digital TechnologyLtd's past further, check out this free graph covering Fanli Digital TechnologyLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

We weren't thrilled with the trend because Fanli Digital TechnologyLtd's ROCE has reduced by 84% over the last five years, while the business employed 132% more capital. That being said, Fanli Digital TechnologyLtd raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Fanli Digital TechnologyLtd might not have received a full period of earnings contribution from it.

On a side note, Fanli Digital TechnologyLtd has done well to pay down its current liabilities to 8.1% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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

We're a bit apprehensive about Fanli Digital TechnologyLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 35% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with Fanli Digital TechnologyLtd (at least 1 which is significant) , and understanding them would certainly be useful.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com