Shinelong Automotive Lightweight Application's (HKG:1930) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. However, after briefly looking over the numbers, we don't think Shinelong Automotive Lightweight Application (HKG:1930) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Shinelong Automotive Lightweight Application is:

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

0.10 = CN¥31m ÷ (CN¥476m - CN¥177m) (Based on the trailing twelve months to December 2020).

Thus, Shinelong Automotive Lightweight Application has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Auto Components industry average of 8.4% it's much better.

View our latest analysis for Shinelong Automotive Lightweight Application

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'd like to look at how Shinelong Automotive Lightweight Application has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Shinelong Automotive Lightweight Application, we didn't gain much confidence. Around four years ago the returns on capital were 34%, but since then they've fallen to 10%. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

On a related note, Shinelong Automotive Lightweight Application has decreased its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. 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 Shinelong Automotive Lightweight Application's ROCE

In summary, we're somewhat concerned by Shinelong Automotive Lightweight Application's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 32% from where it was year ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know about the risks facing Shinelong Automotive Lightweight Application, we've discovered 2 warning signs that you should be aware of.

While Shinelong Automotive Lightweight Application may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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