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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Zkteco (SZSE:301330) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. To calculate this metric for Zkteco, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.057 = CN¥186m ÷ (CN¥3.8b - CN¥545m) (Based on the trailing twelve months to September 2023).
Therefore, Zkteco has an ROCE of 5.7%. On its own, that's a low figure but it's around the 5.3% average generated by the Electronic industry.
Check out our latest analysis for Zkteco
Above you can see how the current ROCE for Zkteco compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Zkteco here for free.
What Does the ROCE Trend For Zkteco Tell Us?
When we looked at the ROCE trend at Zkteco, we didn't gain much confidence. To be more specific, ROCE has fallen from 18% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Zkteco has done well to pay down its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.
Our Take On Zkteco's ROCE
In summary, Zkteco is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 7.4% over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Like most companies, Zkteco does come with some risks, and we've found 1 warning sign that you should be aware of.
While Zkteco may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.