What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Qingmu Digital TechnologyLtd (SZSE:301110), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Qingmu Digital TechnologyLtd:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = CN¥55m ÷ (CN¥1.6b - CN¥105m) (Based on the trailing twelve months to June 2023).
Thus, Qingmu Digital TechnologyLtd has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Multiline Retail industry average of 5.3%.
Check out our latest analysis for Qingmu Digital TechnologyLtd
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 Qingmu Digital TechnologyLtd's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Qingmu Digital TechnologyLtd, we didn't gain much confidence. Around five years ago the returns on capital were 37%, but since then they've fallen to 3.8%. However it looks like Qingmu Digital TechnologyLtd 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 may take some time before the company starts to see any change in earnings from these investments.
On a related note, Qingmu Digital TechnologyLtd has decreased its current liabilities to 6.7% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Key Takeaway
Bringing it all together, while we're somewhat encouraged by Qingmu Digital TechnologyLtd's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 22% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
If you'd like to know about the risks facing Qingmu Digital TechnologyLtd, we've discovered 2 warning signs that you should be aware of.
While Qingmu Digital TechnologyLtd 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.