If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Jiangxi Hungpai New Material (SHSE:605366), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. To calculate this metric for Jiangxi Hungpai New Material, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.029 = CN¥76m ÷ (CN¥3.1b - CN¥440m) (Based on the trailing twelve months to September 2023).
So, Jiangxi Hungpai New Material has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.0%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Jiangxi Hungpai New Material's ROCE against it's prior returns. If you'd like to look at how Jiangxi Hungpai New Material has performed in the past in other metrics, you can view this free graph of Jiangxi Hungpai New Material's past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at Jiangxi Hungpai New Material doesn't inspire confidence. Around five years ago the returns on capital were 31%, but since then they've fallen to 2.9%. 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 side note, Jiangxi Hungpai New Material has done well to pay down its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
In summary, we're somewhat concerned by Jiangxi Hungpai New Material's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 8.7% over the last three years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
On a final note, we found 3 warning signs for Jiangxi Hungpai New Material (2 are a bit unpleasant) you should be aware of.
While Jiangxi Hungpai New Material 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.