Capital Allocation Trends At Northking Information Technology (SZSE:002987) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 briefly looking over the numbers, we don't think Northking Information Technology (SZSE:002987) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Northking Information Technology:

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

0.12 = CN¥308m ÷ (CN¥3.1b - CN¥504m) (Based on the trailing twelve months to March 2024).

Therefore, Northking Information Technology has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 3.9% generated by the IT industry.

Check out our latest analysis for Northking Information Technology

Above you can see how the current ROCE for Northking Information Technology compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Northking Information Technology .

What The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't look fantastic because it's fallen from 21% five years ago, while the business's capital employed increased by 419%. That being said, Northking Information Technology raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Northking Information Technology's earnings and if they change as a result from the capital raise. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

On a side note, Northking Information Technology has done well to pay down its current liabilities to 16% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Bottom Line On Northking Information Technology's ROCE

While returns have fallen for Northking Information Technology in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 0.4% over the last three years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Northking Information Technology (of which 1 can't be ignored!) that you should know about.

While Northking Information Technology 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.

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