Capital Allocation Trends At Jiangsu Xiehe ElectronicLtd (SHSE:605258) Aren't Ideal

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. In light of that, when we looked at Jiangsu Xiehe ElectronicLtd (SHSE:605258) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Jiangsu Xiehe ElectronicLtd, this is the formula:

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

0.037 = CN¥44m ÷ (CN¥1.4b - CN¥244m) (Based on the trailing twelve months to September 2023).

Therefore, Jiangsu Xiehe ElectronicLtd has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Electronic industry average of 5.3%.

Check out our latest analysis for Jiangsu Xiehe ElectronicLtd

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

What Does the ROCE Trend For Jiangsu Xiehe ElectronicLtd Tell Us?

When we looked at the ROCE trend at Jiangsu Xiehe ElectronicLtd, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.7% from 42% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Jiangsu Xiehe ElectronicLtd has decreased its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Jiangsu Xiehe ElectronicLtd's reinvestment in its own business, we're aware that returns are shrinking. And in the last three years, the stock has given away 38% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a final note, we found 2 warning signs for Jiangsu Xiehe ElectronicLtd (1 shouldn't be ignored) you should be aware of.

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.