If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. In light of that, when we looked at Shenzhen Ridge Engineering Consulting (SZSE:300977) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
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 Shenzhen Ridge Engineering Consulting:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0092 = CN¥13m ÷ (CN¥1.6b - CN¥132m) (Based on the trailing twelve months to September 2023).
So, Shenzhen Ridge Engineering Consulting has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.8%.
View our latest analysis for Shenzhen Ridge Engineering Consulting
In the above chart we have measured Shenzhen Ridge Engineering Consulting's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Shenzhen Ridge Engineering Consulting.
The Trend Of ROCE
When we looked at the ROCE trend at Shenzhen Ridge Engineering Consulting, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 0.9% from 59% five years ago. 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, Shenzhen Ridge Engineering Consulting has done well to pay down its current liabilities to 8.5% 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.
In Conclusion...
In summary, we're somewhat concerned by Shenzhen Ridge Engineering Consulting's diminishing returns on increasing amounts of capital. However the stock has delivered a 39% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Shenzhen Ridge Engineering Consulting does have some risks though, and we've spotted 1 warning sign for Shenzhen Ridge Engineering Consulting that you might be interested in.
While Shenzhen Ridge Engineering Consulting 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.