Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at Shenzhen Xinyichang Technology (SHSE:688383), it didn't seem to tick all of these boxes.

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 Shenzhen Xinyichang Technology is:

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

0.023 = CN¥34m ÷ (CN¥2.6b - CN¥1.1b) (Based on the trailing twelve months to September 2023).

So, Shenzhen Xinyichang Technology has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 4.4%.

View our latest analysis for Shenzhen Xinyichang Technology

In the above chart we have measured Shenzhen Xinyichang Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shenzhen Xinyichang Technology here for free.

What Can We Tell From Shenzhen Xinyichang Technology's ROCE Trend?

In terms of Shenzhen Xinyichang Technology's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 24% over the last four years. And considering revenue has dropped while employing more capital, we'd be cautious. 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 separate but related note, it's important to know that Shenzhen Xinyichang Technology has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In summary, we're somewhat concerned by Shenzhen Xinyichang Technology's diminishing returns on increasing amounts of capital. And long term shareholders have watched their investments stay flat over the last year. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Shenzhen Xinyichang Technology (of which 3 are a bit unpleasant!) that you should know about.

While Shenzhen Xinyichang Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.