CSI Solar (SHSE:688472) Might Be Having Difficulty Using Its Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. 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. 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 CSI Solar (SHSE:688472) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on CSI Solar is:

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

0.081 = CN¥2.6b ÷ (CN¥67b - CN¥34b) (Based on the trailing twelve months to September 2024).

Therefore, CSI Solar has an ROCE of 8.1%. On its own that's a low return, but compared to the average of 4.8% generated by the Semiconductor industry, it's much better.

See our latest analysis for CSI Solar

Above you can see how the current ROCE for CSI Solar compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering CSI Solar for free.

How Are Returns Trending?

When we looked at the ROCE trend at CSI Solar, we didn't gain much confidence. To be more specific, ROCE has fallen from 22% over the last five years. 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, CSI Solar has decreased its current liabilities to 51% of total assets. So we could link some of this to the decrease in ROCE. 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. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

What We Can Learn From CSI Solar's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for CSI Solar have fallen, meanwhile the business is employing more capital than it was five years ago. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 26% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing: We've identified 4 warning signs with CSI Solar (at least 1 which doesn't sit too well with us) , and understanding these would certainly be useful.

While CSI Solar isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.