Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Guangdong Topstar Technology (SZSE:300607), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on Guangdong Topstar Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = CN¥207m ÷ (CN¥7.3b - CN¥3.8b) (Based on the trailing twelve months to September 2023).
Therefore, Guangdong Topstar Technology has an ROCE of 5.8%. Even though it's in line with the industry average of 6.0%, it's still a low return by itself.
In the above chart we have measured Guangdong Topstar Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Guangdong Topstar Technology .
The Trend Of ROCE
On the surface, the trend of ROCE at Guangdong Topstar Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.8% from 18% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 52%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 5.8%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
Our Take On Guangdong Topstar Technology's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Guangdong Topstar Technology. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
If you'd like to know about the risks facing Guangdong Topstar Technology, we've discovered 1 warning sign 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.