Colorlight Cloud Tech (SZSE:301391) Is Reinvesting At Lower Rates Of Return

What are the early trends we should look for to identify a stock that could 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Colorlight Cloud Tech (SZSE:301391) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Colorlight Cloud Tech is:

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

0.055 = CN¥120m ÷ (CN¥2.7b - CN¥553m) (Based on the trailing twelve months to September 2023).

Therefore, Colorlight Cloud Tech has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Electronic industry average of 5.2%.

View our latest analysis for Colorlight Cloud Tech

In the above chart we have measured Colorlight Cloud Tech'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 Colorlight Cloud Tech .

How Are Returns Trending?

When we looked at the ROCE trend at Colorlight Cloud Tech, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 5.5% from 58% four 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 related note, Colorlight Cloud Tech has decreased its current liabilities to 20% 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.

What We Can Learn From Colorlight Cloud Tech's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Colorlight Cloud Tech is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 49% over the last year, 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.

If you'd like to know more about Colorlight Cloud Tech, we've spotted 2 warning signs, and 1 of them is potentially serious.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com