Here's What's Concerning About China Leadshine Technology's (SZSE:002979) 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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at China Leadshine Technology (SZSE:002979), it didn't seem to tick all of these boxes.

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 China Leadshine Technology, this is the formula:

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

0.059 = CN¥89m ÷ (CN¥2.3b - CN¥751m) (Based on the trailing twelve months to September 2023).

Thus, China Leadshine Technology has an ROCE of 5.9%. In absolute terms, that's a low return but it's around the Electronic industry average of 5.2%.

Check out our latest analysis for China Leadshine Technology

In the above chart we have measured China Leadshine Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China Leadshine Technology for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at China Leadshine Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.9% from 19% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, China Leadshine Technology's current liabilities have increased over the last five years to 33% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 5.9%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On China Leadshine Technology's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for China Leadshine Technology. And there could be an opportunity here if other metrics look good too, because the stock has declined 33% 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'd like to know about the risks facing China Leadshine Technology, we've discovered 3 warning signs that 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.