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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Ruijie Networks (SZSE:301165), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Ruijie Networks:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = CN¥63m ÷ (CN¥8.0b - CN¥3.6b) (Based on the trailing twelve months to September 2023).
Therefore, Ruijie Networks has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Communications industry average of 5.1%.
View our latest analysis for Ruijie Networks
In the above chart we have measured Ruijie Networks' prior ROCE against its prior performance, but the future is arguably more important. 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 Ruijie Networks Tell Us?
On the surface, the trend of ROCE at Ruijie Networks doesn't inspire confidence. To be more specific, ROCE has fallen from 43% over the last four years. However it looks like Ruijie Networks might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, Ruijie Networks has decreased its current liabilities to 46% of total assets. So we could link some of this to the decrease in ROCE. 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. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Ruijie Networks' reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 5.9% in the last year to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
One more thing: We've identified 4 warning signs with Ruijie Networks (at least 1 which is potentially serious) , and understanding these would certainly be useful.
While Ruijie Networks 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.