What trends should we look for it we want to identify stocks that can 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Zhejiang Guanghua TechnologyLtd (SZSE:001333) and its ROCE trend, we weren't exactly thrilled.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhejiang Guanghua TechnologyLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = CN¥111m ÷ (CN¥2.3b - CN¥703m) (Based on the trailing twelve months to September 2023).
Therefore, Zhejiang Guanghua TechnologyLtd has an ROCE of 7.0%. In absolute terms, that's a low return but it's around 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 Zhejiang Guanghua TechnologyLtd'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 Guanghua TechnologyLtd.
The Trend Of ROCE
We weren't thrilled with the trend because Zhejiang Guanghua TechnologyLtd's ROCE has reduced by 76% over the last four years, while the business employed 368% more capital. That being said, Zhejiang Guanghua TechnologyLtd raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Zhejiang Guanghua TechnologyLtd might not have received a full period of earnings contribution from it.
On a related note, Zhejiang Guanghua TechnologyLtd has decreased its current liabilities to 31% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.
What We Can Learn From Zhejiang Guanghua TechnologyLtd's ROCE
In summary, Zhejiang Guanghua TechnologyLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 38% in the last year. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
On a final note, we found 2 warning signs for Zhejiang Guanghua TechnologyLtd (1 makes us a bit uncomfortable) you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.