Capital Allocation Trends At Ningbo Shimao EnergyLtd (SHSE:605028) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Ningbo Shimao EnergyLtd (SHSE:605028) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Ningbo Shimao EnergyLtd is:

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

0.13 = CN¥187m ÷ (CN¥1.5b - CN¥81m) (Based on the trailing twelve months to March 2024).

Thus, Ningbo Shimao EnergyLtd has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 5.4% generated by the Water Utilities industry.

See our latest analysis for Ningbo Shimao EnergyLtd

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 Ningbo Shimao EnergyLtd's past further, check out this free graph covering Ningbo Shimao EnergyLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Ningbo Shimao EnergyLtd doesn't inspire confidence. To be more specific, ROCE has fallen from 35% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Ningbo Shimao EnergyLtd has decreased its current liabilities to 5.5% 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.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Ningbo Shimao EnergyLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last year have experienced a 24% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Ningbo Shimao EnergyLtd does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is concerning...

While Ningbo Shimao EnergyLtd 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.