Xinjiang Daqo New EnergyLtd (SHSE:688303) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Xinjiang Daqo New EnergyLtd (SHSE:688303), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Xinjiang Daqo New EnergyLtd:

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

0.067 = CN¥3.0b ÷ (CN¥50b - CN¥5.1b) (Based on the trailing twelve months to March 2024).

Thus, Xinjiang Daqo New EnergyLtd has an ROCE of 6.7%. On its own that's a low return, but compared to the average of 3.9% generated by the Semiconductor industry, it's much better.

Check out our latest analysis for Xinjiang Daqo New EnergyLtd

In the above chart we have measured Xinjiang Daqo New EnergyLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Xinjiang Daqo New EnergyLtd for free.

So How Is Xinjiang Daqo New EnergyLtd's ROCE Trending?

On the surface, the trend of ROCE at Xinjiang Daqo New EnergyLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.7% from 9.8% 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, Xinjiang Daqo New EnergyLtd has decreased its current liabilities to 10% 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.

The Bottom Line

In summary, we're somewhat concerned by Xinjiang Daqo New EnergyLtd's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 38% from where it was year ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Xinjiang Daqo New EnergyLtd does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.