Some Investors May Be Worried About Changzhou Aohong Electronics' (SHSE:605058) Returns On 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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Changzhou Aohong Electronics (SHSE:605058) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. To calculate this metric for Changzhou Aohong Electronics, this is the formula:

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

0.057 = CN¥97m ÷ (CN¥2.4b - CN¥714m) (Based on the trailing twelve months to September 2024).

Thus, Changzhou Aohong Electronics has an ROCE of 5.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.5%.

Check out our latest analysis for Changzhou Aohong Electronics

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Changzhou Aohong Electronics.

How Are Returns Trending?

In terms of Changzhou Aohong Electronics' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.7% from 20% 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Changzhou Aohong Electronics has decreased its current liabilities to 29% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Changzhou Aohong Electronics' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Changzhou Aohong Electronics is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 24% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you're still interested in Changzhou Aohong Electronics it's worth checking out our FREE intrinsic value approximation for 605058 to see if it's trading at an attractive price in other respects.

While Changzhou Aohong 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.