Returns On Capital Signal Tricky Times Ahead For Shenzhen Edadoc TechnologyLtd (SZSE:301366)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. 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 Shenzhen Edadoc TechnologyLtd (SZSE:301366) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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What Is Return On Capital Employed (ROCE)?

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 Shenzhen Edadoc TechnologyLtd, this is the formula:

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

0.033 = CN¥78m ÷ (CN¥2.7b - CN¥333m) (Based on the trailing twelve months to September 2024).

Therefore, Shenzhen Edadoc TechnologyLtd has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 5.8%.

Check out our latest analysis for Shenzhen Edadoc TechnologyLtd

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 Shenzhen Edadoc TechnologyLtd's past further, check out this free graph covering Shenzhen Edadoc TechnologyLtd's past earnings, revenue and cash flow.

So How Is Shenzhen Edadoc TechnologyLtd's ROCE Trending?

On the surface, the trend of ROCE at Shenzhen Edadoc TechnologyLtd doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 3.3%. However it looks like Shenzhen Edadoc TechnologyLtd might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Shenzhen Edadoc TechnologyLtd has done well to pay down its current liabilities to 12% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Shenzhen Edadoc TechnologyLtd's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 106% gain to shareholders who have held over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know more about Shenzhen Edadoc TechnologyLtd, we've spotted 4 warning signs, and 3 of them are significant.

While Shenzhen Edadoc TechnologyLtd 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.