Shenzhen Gongjin Electronics (SHSE:603118) Is Finding It Tricky To Allocate Its Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into Shenzhen Gongjin Electronics (SHSE:603118), the trends above didn't look too great.

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. Analysts use this formula to calculate it for Shenzhen Gongjin Electronics:

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

0.029 = CN¥158m ÷ (CN¥9.7b - CN¥4.2b) (Based on the trailing twelve months to March 2024).

Thus, Shenzhen Gongjin Electronics has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 3.9%.

View our latest analysis for Shenzhen Gongjin Electronics

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

What Can We Tell From Shenzhen Gongjin Electronics' ROCE Trend?

We are a bit worried about the trend of returns on capital at Shenzhen Gongjin Electronics. Unfortunately the returns on capital have diminished from the 4.5% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Shenzhen Gongjin Electronics becoming one if things continue as they have.

On a side note, Shenzhen Gongjin Electronics' current liabilities are still rather high at 43% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Shenzhen Gongjin Electronics' ROCE

In summary, it's unfortunate that Shenzhen Gongjin Electronics is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 30% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know about the risks facing Shenzhen Gongjin Electronics, we've discovered 2 warning signs that you should be aware of.

While Shenzhen Gongjin Electronics may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.

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