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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Red Avenue New Materials Group (SHSE:603650), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed 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)
0.038 = CN¥208m ÷ (CN¥7.3b - CN¥1.7b) (Based on the trailing twelve months to September 2023).
So, Red Avenue New Materials Group has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.
Check out our latest analysis for Red Avenue New Materials Group
In the above chart we have measured Red Avenue New Materials Group'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 Does the ROCE Trend For Red Avenue New Materials Group Tell Us?
In terms of Red Avenue New Materials Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 23%, but since then they've fallen to 3.8%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line On Red Avenue New Materials Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Red Avenue New Materials Group is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 78% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we've identified 1 warning sign with Red Avenue New Materials Group and understanding this should be part of your investment process.
While Red Avenue New Materials Group 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.