If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after briefly looking over the numbers, we don't think Nanjing Sunlord Electronics (SZSE:300975) 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)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Nanjing Sunlord Electronics:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = CN¥111m ÷ (CN¥4.3b - CN¥2.1b) (Based on the trailing twelve months to September 2023).
Therefore, Nanjing Sunlord Electronics has an ROCE of 5.0%. Even though it's in line with the industry average of 5.0%, it's still a low return by itself.
Check out our latest analysis for Nanjing Sunlord Electronics
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're interested in investigating Nanjing Sunlord Electronics' past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Nanjing Sunlord Electronics doesn't inspire confidence. Around five years ago the returns on capital were 48%, but since then they've fallen to 5.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 side note, Nanjing Sunlord Electronics' current liabilities have increased over the last five years to 49% 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. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
Our Take On Nanjing Sunlord Electronics' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Nanjing Sunlord Electronics have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 9.8% 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.
One final note, you should learn about the 5 warning signs we've spotted with Nanjing Sunlord Electronics (including 2 which are significant) .
While Nanjing Sunlord Electronics 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.