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. 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 Guoguang ElectricLtd.Chengdu (SHSE:688776) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on Guoguang ElectricLtd.Chengdu is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.045 = CN¥86m ÷ (CN¥2.3b - CN¥376m) (Based on the trailing twelve months to September 2023).
Therefore, Guoguang ElectricLtd.Chengdu has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Electrical industry average of 6.3%.
Check out our latest analysis for Guoguang ElectricLtd.Chengdu
In the above chart we have measured Guoguang ElectricLtd.Chengdu's 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 Can We Tell From Guoguang ElectricLtd.Chengdu's ROCE Trend?
On the surface, the trend of ROCE at Guoguang ElectricLtd.Chengdu doesn't inspire confidence. Over the last four years, returns on capital have decreased to 4.5% from 7.9% four years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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.
The Bottom Line
In summary, we're somewhat concerned by Guoguang ElectricLtd.Chengdu's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 35% over the last year, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you want to know some of the risks facing Guoguang ElectricLtd.Chengdu we've found 2 warning signs (1 can't be ignored!) that you should be aware of before investing here.
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.
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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.