Capital Allocation Trends At IRICO Group New Energy (HKG:438) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating IRICO Group New Energy (HKG:438), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for IRICO Group New Energy, this is the formula:

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

0.036 = CN¥90m ÷ (CN¥5.9b - CN¥3.4b) (Based on the trailing twelve months to June 2022).

Thus, IRICO Group New Energy has an ROCE of 3.6%. Ultimately, that's a low return and it under-performs the Electronic industry average of 6.8%.

View our latest analysis for IRICO Group New Energy

In the above chart we have measured IRICO Group New Energy'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 IRICO Group New Energy.

The Trend Of ROCE

On the surface, the trend of ROCE at IRICO Group New Energy doesn't inspire confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 3.6%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, IRICO Group New Energy has done well to pay down its current liabilities to 58% of total assets. That could partly explain why the ROCE has dropped. 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. Keep in mind 58% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

In summary, we're somewhat concerned by IRICO Group New Energy's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last five years have experienced a 59% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know more about IRICO Group New Energy, we've spotted 2 warning signs, and 1 of them can't be ignored.

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.