What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Having said that, from a first glance at Chengdu Qushui Science and Technology (SZSE:301336) 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 who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Chengdu Qushui Science and Technology:

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

0.013 = CN¥11m ÷ (CN¥858m - CN¥65m) (Based on the trailing twelve months to September 2023).

Therefore, Chengdu Qushui Science and Technology has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 7.9%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chengdu Qushui Science and Technology's ROCE against it's prior returns. If you'd like to look at how Chengdu Qushui Science and Technology has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Chengdu Qushui Science and Technology doesn't inspire confidence. To be more specific, ROCE has fallen from 20% 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.

On a related note, Chengdu Qushui Science and Technology has decreased its current liabilities to 7.6% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Chengdu Qushui Science and Technology's ROCE

In summary, we're somewhat concerned by Chengdu Qushui Science and Technology's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last year have experienced a 44% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Chengdu Qushui Science and Technology (of which 2 are a bit concerning!) that you should know about.

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.