If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Zhejiang Zhongke Magnetic Industry (SZSE:301141), it didn't seem to tick all of these boxes.

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

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. Analysts use this formula to calculate it for Zhejiang Zhongke Magnetic Industry:

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

0.0021 = CN¥2.7m ÷ (CN¥1.4b - CN¥143m) (Based on the trailing twelve months to March 2024).

Thus, Zhejiang Zhongke Magnetic Industry has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 6.7%.

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'd like to look at how Zhejiang Zhongke Magnetic Industry has performed in the past in other metrics, you can view this free graph of Zhejiang Zhongke Magnetic Industry's past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Zhejiang Zhongke Magnetic Industry's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 16% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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, Zhejiang Zhongke Magnetic Industry has done well to pay down its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Zhejiang Zhongke Magnetic Industry's ROCE

In summary, we're somewhat concerned by Zhejiang Zhongke Magnetic Industry's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 15% return over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we found 3 warning signs for Zhejiang Zhongke Magnetic Industry (2 can't be ignored) you should be aware of.

While Zhejiang Zhongke Magnetic Industry 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com