What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think GKG Precision Machine (SZSE:301338) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for GKG Precision Machine:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = CN¥70m ÷ (CN¥1.9b - CN¥479m) (Based on the trailing twelve months to June 2023).
Therefore, GKG Precision Machine has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.4%.
See our latest analysis for GKG Precision Machine
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'd like to look at how GKG Precision Machine has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
On the surface, the trend of ROCE at GKG Precision Machine doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.0% from 36% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a related note, GKG Precision Machine has decreased its current liabilities to 25% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From GKG Precision Machine's ROCE
We're a bit apprehensive about GKG Precision Machine because despite more capital being deployed in the business, returns on that capital and sales have both fallen. And long term shareholders have watched their investments stay flat over the last year. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
GKG Precision Machine does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
While GKG Precision Machine 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.