When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Zhejiang Dehong Automotive Electronic & Electrical (SHSE:603701), the trends above didn't look too great.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhejiang Dehong Automotive Electronic & Electrical, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = CN¥14m ÷ (CN¥1.0b - CN¥211m) (Based on the trailing twelve months to September 2023).
Thus, Zhejiang Dehong Automotive Electronic & Electrical has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 5.8%.
See our latest analysis for Zhejiang Dehong Automotive Electronic & Electrical
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Zhejiang Dehong Automotive Electronic & Electrical's past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From Zhejiang Dehong Automotive Electronic & Electrical's ROCE Trend?
In terms of Zhejiang Dehong Automotive Electronic & Electrical's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 10.0% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Zhejiang Dehong Automotive Electronic & Electrical to turn into a multi-bagger.
Our Take On Zhejiang Dehong Automotive Electronic & Electrical's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Since the stock has skyrocketed 166% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you want to know some of the risks facing Zhejiang Dehong Automotive Electronic & Electrical we've found 3 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.
While Zhejiang Dehong Automotive Electronic & Electrical isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
