Shanghai Allied Industrial (SZSE:301419) Might Be Having Difficulty Using Its Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. 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. In light of that, when we looked at Shanghai Allied Industrial (SZSE:301419) and its ROCE trend, we weren't exactly thrilled.

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

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 Shanghai Allied Industrial is:

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

0.091 = CN¥88m ÷ (CN¥1.1b - CN¥116m) (Based on the trailing twelve months to September 2023).

So, Shanghai Allied Industrial has an ROCE of 9.1%. In absolute terms, that's a low return, but it's much better than the Communications industry average of 5.1%.

Check out our latest analysis for Shanghai Allied Industrial

In the above chart we have measured Shanghai Allied Industrial'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 Shanghai Allied Industrial .

How Are Returns Trending?

On the surface, the trend of ROCE at Shanghai Allied Industrial doesn't inspire confidence. To be more specific, ROCE has fallen from 56% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Shanghai Allied Industrial has decreased its current liabilities to 11% of total assets. So we could link some of this to the decrease in ROCE. 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.

What We Can Learn From Shanghai Allied Industrial's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Shanghai Allied Industrial. These growth trends haven't led to growth returns though, since the stock has fallen 31% over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Shanghai Allied Industrial does have some risks, we noticed 2 warning signs (and 1 which can't be ignored) we think you should know about.

While Shanghai Allied Industrial 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.