There Are Reasons To Feel Uneasy About Xinyi Electric Storage Holdings' (HKG:8328) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Xinyi Electric Storage Holdings (HKG:8328) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on Xinyi Electric Storage Holdings is:

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

0.053 = HK$66m ÷ (HK$2.3b - HK$1.0b) (Based on the trailing twelve months to September 2023).

So, Xinyi Electric Storage Holdings has an ROCE of 5.3%. On its own, that's a low figure but it's around the 5.7% average generated by the Electrical industry.

View our latest analysis for Xinyi Electric Storage Holdings

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 Xinyi Electric Storage Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Xinyi Electric Storage Holdings doesn't inspire confidence. Around five years ago the returns on capital were 7.3%, but since then they've fallen to 5.3%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Xinyi Electric Storage Holdings' current liabilities have increased over the last five years to 45% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

What We Can Learn From Xinyi Electric Storage Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Xinyi Electric Storage Holdings is reinvesting for growth and has higher sales as a result. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Like most companies, Xinyi Electric Storage Holdings does come with some risks, and we've found 1 warning sign that you should be aware of.

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.

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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.