What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. However, after briefly looking over the numbers, we don't think Jiangxi Hungpai New Material (SHSE:605366) 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)
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 Jiangxi Hungpai New Material is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.029 = CN¥76m ÷ (CN¥3.1b - CN¥440m) (Based on the trailing twelve months to September 2023).
So, Jiangxi Hungpai New Material has an ROCE of 2.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.
View our latest analysis for Jiangxi Hungpai New Material
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 want to delve into the historical earnings, revenue and cash flow of Jiangxi Hungpai New Material, check out these free graphs here.
What Does the ROCE Trend For Jiangxi Hungpai New Material Tell Us?
When we looked at the ROCE trend at Jiangxi Hungpai New Material, we didn't gain much confidence. Around five years ago the returns on capital were 31%, but since then they've fallen to 2.9%. 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.
On a related note, Jiangxi Hungpai New Material has decreased its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
What We Can Learn From Jiangxi Hungpai New Material's ROCE
In summary, we're somewhat concerned by Jiangxi Hungpai New Material's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last three yearsthe stock has delivered a respectable 50% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Jiangxi Hungpai New Material does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are significant...
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.