What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at GKG Precision Machine (SZSE:301338) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for GKG Precision Machine, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = CN¥37m ÷ (CN¥2.0b - CN¥590m) (Based on the trailing twelve months to September 2023).
So, GKG Precision Machine has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.0%.
Check out our latest analysis for GKG Precision Machine
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'd like to look at how GKG Precision Machine has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
In terms of GKG Precision Machine's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.6% from 31% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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, GKG Precision Machine has done well to pay down its current liabilities to 29% 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.
The Bottom Line
From the above analysis, we find it rather worrisome that returns on capital and sales for GKG Precision Machine have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 19% from where it was year ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for GKG Precision Machine (of which 1 is a bit concerning!) that you should know about.
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.
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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.