If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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 Red Avenue New Materials Group (SHSE:603650), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Red Avenue New Materials Group is:

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

0.034 = CN¥139m ÷ (CN¥6.3b - CN¥2.2b) (Based on the trailing twelve months to June 2022).

Thus, Red Avenue New Materials Group has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 10.0%.

See our latest analysis for Red Avenue New Materials Group

Above you can see how the current ROCE for Red Avenue New Materials Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Red Avenue New Materials Group Tell Us?

When we looked at the ROCE trend at Red Avenue New Materials Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.4% from 34% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line On Red Avenue New Materials Group's ROCE

Bringing it all together, while we're somewhat encouraged by Red Avenue New Materials Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 97% over the last three years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we found 4 warning signs for Red Avenue New Materials Group (1 is a bit unpleasant) 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.