Flowing Cloud Technology's (HKG:6610) Returns On Capital Not Reflecting Well On The Business

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Flowing Cloud Technology (HKG:6610), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Flowing Cloud Technology:

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

0.22 = CN¥285m ÷ (CN¥1.6b - CN¥326m) (Based on the trailing twelve months to June 2023).

Thus, Flowing Cloud Technology has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Media industry average of 8.7%.

See our latest analysis for Flowing Cloud Technology

In the above chart we have measured Flowing Cloud Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Flowing Cloud Technology.

So How Is Flowing Cloud Technology's ROCE Trending?

On the surface, the trend of ROCE at Flowing Cloud Technology doesn't inspire confidence. While it's comforting that the ROCE is high, three years ago it was 41%. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Flowing Cloud Technology has done well to pay down its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Flowing Cloud Technology's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Flowing Cloud Technology. And there could be an opportunity here if other metrics look good too, because the stock has declined 57% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to continue researching Flowing Cloud Technology, you might be interested to know about the 1 warning sign that our analysis has discovered.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.