What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Sichuan Dawn Precision TechnologyLtd (SZSE:300780) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Sichuan Dawn Precision TechnologyLtd, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.017 = CN¥31m ÷ (CN¥2.1b - CN¥214m) (Based on the trailing twelve months to September 2023).

So, Sichuan Dawn Precision TechnologyLtd has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.1%.

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 Sichuan Dawn Precision TechnologyLtd's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Sichuan Dawn Precision TechnologyLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 16%, but since then they've fallen to 1.7%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Sichuan Dawn Precision TechnologyLtd has done well to pay down its current liabilities to 10% 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.

Our Take On Sichuan Dawn Precision TechnologyLtd's ROCE

In summary, we're somewhat concerned by Sichuan Dawn Precision TechnologyLtd's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 4.5% over the last three years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing, we've spotted 4 warning signs facing Sichuan Dawn Precision TechnologyLtd that you might find interesting.

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.