Shenzhen Farben Information TechnologyLtd (SZSE:300925) Could Be Struggling To Allocate Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Although, when we looked at Shenzhen Farben Information TechnologyLtd (SZSE:300925), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Shenzhen Farben Information TechnologyLtd, this is the formula:

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

0.055 = CN¥115m ÷ (CN¥2.8b - CN¥704m) (Based on the trailing twelve months to September 2024).

Therefore, Shenzhen Farben Information TechnologyLtd has an ROCE of 5.5%. On its own that's a low return, but compared to the average of 3.7% generated by the IT industry, it's much better.

See our latest analysis for Shenzhen Farben Information TechnologyLtd

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 Shenzhen Farben Information TechnologyLtd has performed in the past in other metrics, you can view this free graph of Shenzhen Farben Information TechnologyLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Shenzhen Farben Information TechnologyLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.5% from 25% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Shenzhen Farben Information TechnologyLtd has decreased its current liabilities to 25% 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.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Shenzhen Farben Information TechnologyLtd. And the stock has followed suit returning a meaningful 26% to shareholders over the last three years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you'd like to know more about Shenzhen Farben Information TechnologyLtd, we've spotted 2 warning signs, and 1 of them is concerning.

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.