If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Zhejiang Jiahua Energy Chemical IndustryLtd (SHSE:600273), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Zhejiang Jiahua Energy Chemical IndustryLtd:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = CN¥1.3b ÷ (CN¥12b - CN¥1.7b) (Based on the trailing twelve months to September 2023).
Therefore, Zhejiang Jiahua Energy Chemical IndustryLtd has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 6.1% generated by the Chemicals industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang Jiahua Energy Chemical IndustryLtd's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Zhejiang Jiahua Energy Chemical IndustryLtd.
What Can We Tell From Zhejiang Jiahua Energy Chemical IndustryLtd's ROCE Trend?
On the surface, the trend of ROCE at Zhejiang Jiahua Energy Chemical IndustryLtd doesn't inspire confidence. To be more specific, ROCE has fallen from 20% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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.
The Bottom Line
From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Jiahua Energy Chemical IndustryLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 28% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
One more thing to note, we've identified 1 warning sign with Zhejiang Jiahua Energy Chemical IndustryLtd and understanding this should be part of your investment process.
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.