Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. In light of that, when we looked at Dongguan Aohai Technology (SZSE:002993) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for Dongguan Aohai Technology, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.069 = CN¥340m ÷ (CN¥7.3b - CN¥2.3b) (Based on the trailing twelve months to June 2023).
Thus, Dongguan Aohai Technology has an ROCE of 6.9%. On its own that's a low return, but compared to the average of 5.1% generated by the Tech industry, it's much better.
In the above chart we have measured Dongguan Aohai Technology's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Dongguan Aohai Technology Tell Us?
We weren't thrilled with the trend because Dongguan Aohai Technology's ROCE has reduced by 56% over the last five years, while the business employed 859% more capital. That being said, Dongguan Aohai Technology raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Dongguan Aohai Technology probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
On a related note, Dongguan Aohai Technology has decreased its current liabilities to 32% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Dongguan Aohai Technology's ROCE
In summary, Dongguan Aohai Technology is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 21% in the last three years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Like most companies, Dongguan Aohai Technology does come with some risks, and we've found 2 warning signs that you should be aware of.
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.