Sichuan Joyou Digital TechnologiesLtd (SZSE:301172) May Have Issues Allocating Its Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Sichuan Joyou Digital TechnologiesLtd (SZSE:301172) and its ROCE trend, we weren't exactly thrilled.

What Is 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 Sichuan Joyou Digital TechnologiesLtd:

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

0.022 = CN¥32m ÷ (CN¥1.8b - CN¥310m) (Based on the trailing twelve months to September 2024).

Thus, Sichuan Joyou Digital TechnologiesLtd has an ROCE of 2.2%. In absolute terms, that's a low return and it also under-performs the IT industry average of 3.7%.

See our latest analysis for Sichuan Joyou Digital TechnologiesLtd

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 Sichuan Joyou Digital TechnologiesLtd has performed in the past in other metrics, you can view this free graph of Sichuan Joyou Digital TechnologiesLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sichuan Joyou Digital TechnologiesLtd doesn't inspire confidence. To be more specific, ROCE has fallen from 31% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Sichuan Joyou Digital TechnologiesLtd has decreased its current liabilities to 18% of total assets. That could partly explain why the ROCE has dropped. 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...

To conclude, we've found that Sichuan Joyou Digital TechnologiesLtd is reinvesting in the business, but returns have been falling. And in the last year, the stock has given away 16% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with Sichuan Joyou Digital TechnologiesLtd (including 1 which is concerning) .

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.

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

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.