What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Jiangxi Chenguang New Materials (SHSE:605399), we don't think it's current trends fit the mold of a multi-bagger.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Jiangxi Chenguang New Materials:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = CN¥60m ÷ (CN¥2.8b - CN¥477m) (Based on the trailing twelve months to September 2023).
Thus, Jiangxi Chenguang New Materials has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.8%.
Above you can see how the current ROCE for Jiangxi Chenguang New Materials compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Jiangxi Chenguang New Materials for free.
The Trend Of ROCE
In terms of Jiangxi Chenguang New Materials' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 37% 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 Jiangxi Chenguang New Materials have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 43% return to shareholders over the last three years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Jiangxi Chenguang New Materials does have some risks, we noticed 4 warning signs (and 1 which can't be ignored) we think you should know about.
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.