Fengzhushou (SZSE:301382) 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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Fengzhushou (SZSE:301382), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Fengzhushou is:

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

0.085 = CN¥165m ÷ (CN¥2.9b - CN¥945m) (Based on the trailing twelve months to September 2024).

Thus, Fengzhushou has an ROCE of 8.5%. In absolute terms, that's a low return, but it's much better than the IT industry average of 3.6%.

See our latest analysis for Fengzhushou

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

The Trend Of ROCE

On the surface, the trend of ROCE at Fengzhushou doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 8.5%. 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. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Fengzhushou's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Fengzhushou is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 162% return over the last year, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing, we've spotted 2 warning signs facing Fengzhushou that you might find interesting.

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.

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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.