To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. 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 Zhuhai Raysharp TechnologyLtd (SZSE:301042) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
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. To calculate this metric for Zhuhai Raysharp TechnologyLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = CN¥45m ÷ (CN¥1.3b - CN¥138m) (Based on the trailing twelve months to September 2023).
Therefore, Zhuhai Raysharp TechnologyLtd has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Electronic industry average of 5.0%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhuhai Raysharp TechnologyLtd's ROCE against it's prior returns. If you're interested in investigating Zhuhai Raysharp TechnologyLtd's past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
On the surface, the trend of ROCE at Zhuhai Raysharp TechnologyLtd doesn't inspire confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 4.0%. 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, Zhuhai Raysharp TechnologyLtd has done well to pay down its current liabilities to 11% 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.
What We Can Learn From Zhuhai Raysharp TechnologyLtd's ROCE
In summary, we're somewhat concerned by Zhuhai Raysharp TechnologyLtd's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last year have experienced a 25% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Zhuhai Raysharp TechnologyLtd (of which 1 is significant!) that you should know about.
While Zhuhai Raysharp 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.