There Are Reasons To Feel Uneasy About Canaan's (NASDAQ:CAN) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Canaan (NASDAQ:CAN) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Canaan:

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

0.13 = CN¥558m ÷ (CN¥4.9b - CN¥448m) (Based on the trailing twelve months to December 2022).

So, Canaan has an ROCE of 13%. By itself that's a normal return on capital and it's in line with the industry's average returns of 13%.

See our latest analysis for Canaan

Above you can see how the current ROCE for Canaan compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Canaan.

What Does the ROCE Trend For Canaan Tell Us?

In terms of Canaan's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 46% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Canaan has done well to pay down its current liabilities to 9.2% 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.

The Bottom Line On Canaan's ROCE

In summary, we're somewhat concerned by Canaan's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 28% from where it was three years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know about the risks facing Canaan, we've discovered 2 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.

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