Leoch International Technology (HKG:842) May Have Issues Allocating Its Capital

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Leoch International Technology (HKG:842) and its ROCE trend, we weren't exactly thrilled.

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 Leoch International Technology is:

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

0.08 = CN¥322m ÷ (CN¥9.3b - CN¥5.3b) (Based on the trailing twelve months to June 2021).

Therefore, Leoch International Technology has an ROCE of 8.0%. In absolute terms, that's a low return but it's around the Electrical industry average of 9.4%.

View our latest analysis for Leoch International Technology

Above you can see how the current ROCE for Leoch International Technology compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Leoch International Technology here for free.

What Can We Tell From Leoch International Technology's ROCE Trend?

When we looked at the ROCE trend at Leoch International Technology, we didn't gain much confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 8.0%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, Leoch International Technology has a high ratio of current liabilities to total assets of 57%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

While returns have fallen for Leoch International Technology in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 50% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Leoch International Technology does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.