If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Although, when we looked at Chutian Dragon (SZSE:003040), it didn't seem to tick all of these boxes.
What Is 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. The formula for this calculation on Chutian Dragon is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = CN¥118m ÷ (CN¥2.1b - CN¥585m) (Based on the trailing twelve months to September 2023).
Therefore, Chutian Dragon has an ROCE of 7.7%. In absolute terms, that's a low return, but it's much better than the Semiconductor industry average of 5.5%.
In the above chart we have measured Chutian Dragon's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Chutian Dragon for free.
So How Is Chutian Dragon's ROCE Trending?
On the surface, the trend of ROCE at Chutian Dragon doesn't inspire confidence. Around five years ago the returns on capital were 9.6%, but since then they've fallen to 7.7%. 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.
Our Take On Chutian Dragon's ROCE
We're a bit apprehensive about Chutian Dragon because despite more capital being deployed in the business, returns on that capital and sales have both fallen. But investors must be expecting an improvement of sorts because over the last three yearsthe stock has delivered a respectable 27% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Like most companies, Chutian Dragon does come with some risks, and we've found 1 warning sign that you should be aware of.
While Chutian Dragon may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.