What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Although, when we looked at Dongguan Dingtong Precision Metal (SHSE:688668), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Dongguan Dingtong Precision Metal:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = CN¥69m ÷ (CN¥1.9b - CN¥152m) (Based on the trailing twelve months to December 2023).
So, Dongguan Dingtong Precision Metal has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.4%.
In the above chart we have measured Dongguan Dingtong Precision Metal'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 analyst report for Dongguan Dingtong Precision Metal .
So How Is Dongguan Dingtong Precision Metal's ROCE Trending?
In terms of Dongguan Dingtong Precision Metal's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 25% over the last five years. 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 related note, Dongguan Dingtong Precision Metal has decreased its current liabilities to 7.8% 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.
What We Can Learn From Dongguan Dingtong Precision Metal's ROCE
In summary, we're somewhat concerned by Dongguan Dingtong Precision Metal's diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 189% over the last three years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with Dongguan Dingtong Precision Metal (including 1 which shouldn't be ignored) .
While Dongguan Dingtong Precision Metal 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.