Capital allocation trends at Farsoon Technologies (SHSE:688433) are not ideal

Did you know that there are some financial metrics that can provide clues about a potential multi-bagger? In a perfect world, we would like to see a company invest more capital into its business and, ideally, the returns generated from that capital also increase. When you see this, it usually means it’s a company with a great business model and plenty of profitable reinvestment opportunities. With this in mind, we looked at it Farsoon Technologies (SHSE:688433) and its ROCE trend, we weren’t exactly thrilled.

Understand return on capital employed (ROCE).

Just to clarify in case you’re not sure, ROCE is a measure used to evaluate how much pre-tax income (as a percentage) a company earns from the capital invested in its business. To calculate this metric for Farsoon Technologies, this is the formula:

Return on capital employed = Earnings before interest and taxes (EBIT) ÷ (total assets – current liabilities)

0.046 = CN¥93 million ÷ (CN¥2.3 billion – CN¥327 million) (Based on the last twelve months ended June 2024).

Therefore, Farsoon Technologies has an ROCE of 4.6%. On its own, that’s a low return on capital, but it’s in line with the industry average return of 5.5%.

Check out our latest analysis for Farsoon Technologies

In the chart above, we measured Farsoon Technologies’ past ROCE compared to its previous performance, but the future is arguably more important. If you want to see what analysts are predicting for the future, you should check out our free analyst report for Farsoon Technologies.

The trend of ROCE

When we looked at Farsoon Technologies’ ROCE trend, we weren’t very confident. More specifically, ROCE has fallen from 8.3% over the last four years. However, as both capital employed and revenue have increased, it appears that the company is currently committed to growth based on short-term earnings. If these investments prove successful, it can bode well for long-term stock performance.

In this regard, Farsoon Technologies has reduced its current liabilities to 14% of total assets. So we could attribute some of that to the decline in ROCE. In effect, this means that their suppliers or short-term creditors are financing a smaller portion of the business, reducing some elements of risk. Some would argue that this reduces the company’s efficiency in generating ROCE as it now finances a larger portion of its operations from its own resources.

The conclusion

Even though returns on capital have declined in the short term, we think it’s encouraging that both revenue and capital employed have increased for Farsoon Technologies. However, these growth trends have not translated into growth returns, as the stock has fallen 33% over the last year. Therefore, we think it would be worth taking a closer look at this stock as the trends look encouraging.

One more thing: we have identified ourselves 2 warning signs with Farsoon Technologies (at least 1, which is significant), and it would certainly be useful to understand these.

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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term focused analysis based on fundamental data. Note that our analysis may not reflect the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.