Here's What's Concerning About Nanjing Sunlord Electronics' (SZSE:300975) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at Nanjing Sunlord Electronics (SZSE:300975), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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 Nanjing Sunlord Electronics is:

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

0.05 = CN¥111m ÷ (CN¥4.3b - CN¥2.1b) (Based on the trailing twelve months to September 2023).

Therefore, Nanjing Sunlord Electronics has an ROCE of 5.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.3%.

Check out our latest analysis for Nanjing Sunlord Electronics

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 Nanjing Sunlord Electronics' past further, check out this free graph covering Nanjing Sunlord Electronics' past earnings, revenue and cash flow.

What Does the ROCE Trend For Nanjing Sunlord Electronics Tell Us?

When we looked at the ROCE trend at Nanjing Sunlord Electronics, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.0% from 48% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 49%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 5.0%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line On Nanjing Sunlord Electronics' ROCE

In summary, we're somewhat concerned by Nanjing Sunlord Electronics' diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 14% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we found 5 warning signs for Nanjing Sunlord Electronics (2 shouldn't be ignored) you should be aware of.

While Nanjing Sunlord Electronics 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.