Returns On Capital Signal Tricky Times Ahead For Northking Information Technology (SZSE:002987)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Having said that, from a first glance at Northking Information Technology (SZSE:002987) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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. To calculate this metric for Northking Information Technology, this is the formula:

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

0.11 = CN¥301m ÷ (CN¥3.2b - CN¥514m) (Based on the trailing twelve months to September 2024).

Therefore, Northking Information Technology has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the IT industry average of 3.6% it's much better.

See our latest analysis for Northking Information Technology

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Northking Information Technology has performed in the past in other metrics, you can view this free graph of Northking Information Technology's past earnings, revenue and cash flow.

What Does the ROCE Trend For Northking Information Technology Tell Us?

When we looked at the ROCE trend at Northking Information Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 27% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Northking Information Technology's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Northking Information Technology. Furthermore the stock has climbed 75% over the last three years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Northking Information Technology does have some risks though, and we've spotted 2 warning signs for Northking Information Technology that you might be interested in.

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.