There Are Reasons To Feel Uneasy About Shandong Fengxiang's (HKG:9977) Returns On 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Shandong Fengxiang (HKG:9977) 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)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Shandong Fengxiang, this is the formula:

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

0.019 = CN¥81m ÷ (CN¥6.9b - CN¥2.7b) (Based on the trailing twelve months to December 2021).

Therefore, Shandong Fengxiang has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Food industry average of 9.6%.

See our latest analysis for Shandong Fengxiang

In the above chart we have measured Shandong Fengxiang's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at Shandong Fengxiang doesn't inspire confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 1.9%. 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 related note, Shandong Fengxiang has decreased its current liabilities to 39% 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.

Our Take On Shandong Fengxiang's ROCE

While returns have fallen for Shandong Fengxiang in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 45% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Shandong Fengxiang does have some risks though, and we've spotted 2 warning signs for Shandong Fengxiang that you might be interested in.

While Shandong Fengxiang 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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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.