ChinaEtek Service & Technology's (SZSE:301208) Returns On Capital Not Reflecting Well On The Business

There are a few key trends to look for if we want to identify the next multi-bagger. 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. In light of that, when we looked at ChinaEtek Service & Technology (SZSE:301208) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for ChinaEtek Service & Technology:

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

0.078 = CN¥117m ÷ (CN¥1.9b - CN¥371m) (Based on the trailing twelve months to September 2024).

So, ChinaEtek Service & Technology has an ROCE of 7.8%. 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.

Check out our latest analysis for ChinaEtek Service & Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for ChinaEtek Service & Technology's ROCE against it's prior returns. If you'd like to look at how ChinaEtek Service & Technology has performed in the past in other metrics, you can view this free graph of ChinaEtek Service & Technology's past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at ChinaEtek Service & Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.8% from 25% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, ChinaEtek Service & Technology has decreased its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. 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

In summary, we're somewhat concerned by ChinaEtek Service & Technology's diminishing returns on increasing amounts of capital. However the stock has delivered a 42% return to shareholders over the last year, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

ChinaEtek Service & Technology does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those make us uncomfortable...

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.