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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Keystone TechnologyLtd (SHSE:605588) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Keystone TechnologyLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.047 = CN¥55m ÷ (CN¥1.7b - CN¥536m) (Based on the trailing twelve months to September 2023).
So, Keystone TechnologyLtd has an ROCE of 4.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.4%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Keystone TechnologyLtd's past further, check out this free graph covering Keystone TechnologyLtd's past earnings, revenue and cash flow.
So How Is Keystone TechnologyLtd's ROCE Trending?
We weren't thrilled with the trend because Keystone TechnologyLtd's ROCE has reduced by 83% over the last five years, while the business employed 369% more capital. Usually this isn't ideal, but given Keystone TechnologyLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Keystone TechnologyLtd probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
The Key Takeaway
In summary, we're somewhat concerned by Keystone TechnologyLtd's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 10% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Keystone TechnologyLtd does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those make us uncomfortable...
While Keystone TechnologyLtd 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.