If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Fujian Kuncai Material Technology (SHSE:603826), 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. Analysts use this formula to calculate it for Fujian Kuncai Material Technology:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.037 = CN¥104m ÷ (CN¥4.1b - CN¥1.4b) (Based on the trailing twelve months to September 2023).
Thus, Fujian Kuncai Material Technology has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.
See our latest analysis for Fujian Kuncai Material Technology
Above you can see how the current ROCE for Fujian Kuncai Material Technology compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Fujian Kuncai Material Technology.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Fujian Kuncai Material Technology, we didn't gain much confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 3.8%. However it looks like Fujian Kuncai Material Technology 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, Fujian Kuncai Material Technology's current liabilities have increased over the last five years to 33% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Fujian Kuncai Material Technology's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 248% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a final note, we found 2 warning signs for Fujian Kuncai Material Technology (1 is significant) you should be aware of.
While Fujian Kuncai Material Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.