There Are Reasons To Feel Uneasy About Leaguer (Shenzhen) Microelectronics' (SHSE:688589) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Having said that, from a first glance at Leaguer (Shenzhen) Microelectronics (SHSE:688589) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Leaguer (Shenzhen) Microelectronics:

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

0.065 = CN¥85m ÷ (CN¥1.4b - CN¥132m) (Based on the trailing twelve months to June 2024).

Thus, Leaguer (Shenzhen) Microelectronics has an ROCE of 6.5%. In absolute terms, that's a low return, but it's much better than the Semiconductor industry average of 4.3%.

See our latest analysis for Leaguer (Shenzhen) Microelectronics

Historical performance is a great place to start when researching a stock so above you can see the gauge for Leaguer (Shenzhen) Microelectronics' 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 Leaguer (Shenzhen) Microelectronics.

What Does the ROCE Trend For Leaguer (Shenzhen) Microelectronics Tell Us?

On the surface, the trend of ROCE at Leaguer (Shenzhen) Microelectronics doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.5% from 13% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Leaguer (Shenzhen) Microelectronics has done well to pay down its current liabilities to 9.1% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Leaguer (Shenzhen) Microelectronics is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 23% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Leaguer (Shenzhen) Microelectronics does have some risks though, and we've spotted 2 warning signs for Leaguer (Shenzhen) Microelectronics that you might be interested in.

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.