Returns On Capital Signal Tricky Times Ahead For China Leadshine Technology (SZSE:002979)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think China Leadshine Technology (SZSE:002979) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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. The formula for this calculation on China Leadshine Technology is:

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).

So, China Leadshine Technology has an ROCE of 5.9%. On its own, that's a low figure but it's around the 5.4% average generated by the Electronic industry.

View 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 to see what analysts are forecasting going forward, you should check out our free analyst report for China Leadshine Technology .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at China Leadshine Technology, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 5.9%. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 33%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 5.9%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that China Leadshine Technology is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 38% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing to note, we've identified 3 warning signs with China Leadshine Technology and understanding these should be part of your investment process.

While China Leadshine Technology 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.