Union OptechLtd (SZSE:300691) Could Be Struggling To Allocate 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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Union OptechLtd (SZSE:300691) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Union OptechLtd, this is the formula:

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

0.011 = CN¥23m ÷ (CN¥2.6b - CN¥515m) (Based on the trailing twelve months to September 2023).

Thus, Union OptechLtd has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the Electronic industry average of 5.4%.

See our latest analysis for Union OptechLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Union OptechLtd's ROCE against it's prior returns. If you're interested in investigating Union OptechLtd's past further, check out this free graph covering Union OptechLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Union OptechLtd, we didn't gain much confidence. Around five years ago the returns on capital were 5.2%, but since then they've fallen to 1.1%. 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, Union OptechLtd has done well to pay down its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

While returns have fallen for Union OptechLtd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 25% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a final note, we found 3 warning signs for Union OptechLtd (1 is a bit unpleasant) you should be aware of.

While Union OptechLtd 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.