Be Wary Of Shenzhen Huaqiang Industry (SZSE:000062) And Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Shenzhen Huaqiang Industry (SZSE:000062) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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. Analysts use this formula to calculate it for Shenzhen Huaqiang Industry:

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

0.11 = CN¥960m ÷ (CN¥17b - CN¥7.6b) (Based on the trailing twelve months to September 2023).

Thus, Shenzhen Huaqiang Industry has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 5.4% generated by the Electronic industry.

View our latest analysis for Shenzhen Huaqiang Industry

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're interested in investigating Shenzhen Huaqiang Industry's past further, check out this free graph covering Shenzhen Huaqiang Industry's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 16% five years ago, while capital employed has grown 52%. Usually this isn't ideal, but given Shenzhen Huaqiang Industry conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Shenzhen Huaqiang Industry probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a side note, Shenzhen Huaqiang Industry's current liabilities are still rather high at 46% 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Shenzhen Huaqiang Industry's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Shenzhen Huaqiang Industry have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 36% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we found 2 warning signs for Shenzhen Huaqiang Industry (1 makes us a bit uncomfortable) you should be aware of.

While Shenzhen Huaqiang Industry isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.