Capital Allocation Trends At Zhejiang Dahua Technology (SZSE:002236) 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? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 investigating Zhejiang Dahua Technology (SZSE:002236), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhejiang Dahua Technology, this is the formula:

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

0.066 = CN¥2.3b ÷ (CN¥49b - CN¥14b) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Dahua Technology has an ROCE of 6.6%. On its own that's a low return, but compared to the average of 5.4% generated by the Electronic industry, it's much better.

Check out our latest analysis for Zhejiang Dahua Technology

In the above chart we have measured Zhejiang Dahua Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Zhejiang Dahua Technology .

So How Is Zhejiang Dahua Technology's ROCE Trending?

When we looked at the ROCE trend at Zhejiang Dahua Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 22% over the last five years. 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 side note, Zhejiang Dahua Technology has done well to pay down 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Zhejiang Dahua Technology's ROCE

To conclude, we've found that Zhejiang Dahua Technology is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 20% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

One more thing to note, we've identified 2 warning signs with Zhejiang Dahua Technology and understanding them should be part of your investment process.

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.