There are a few key trends to look for if we want to identify the next multi-bagger. 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 Zhejiang Tongxing Technology (SZSE:301252) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding 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 Zhejiang Tongxing Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.095 = CN¥114m ÷ (CN¥1.7b - CN¥463m) (Based on the trailing twelve months to September 2024).
Thus, Zhejiang Tongxing Technology has an ROCE of 9.5%. In absolute terms, that's a low return, but it's much better than the Machinery industry average of 5.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang Tongxing Technology's ROCE against it's prior returns. If you're interested in investigating Zhejiang Tongxing Technology's past further, check out this free graph covering Zhejiang Tongxing Technology's past earnings, revenue and cash flow.
What Does the ROCE Trend For Zhejiang Tongxing Technology Tell Us?
On the surface, the trend of ROCE at Zhejiang Tongxing Technology doesn't inspire confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 9.5%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Zhejiang Tongxing Technology has done well to pay down its current liabilities to 28% 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.
The Bottom Line
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Zhejiang Tongxing Technology. Furthermore the stock has climbed 30% over the last year, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
One final note, you should learn about the 2 warning signs we've spotted with Zhejiang Tongxing Technology (including 1 which is a bit unpleasant) .
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.
