There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. So when we looked at ZJMI Environmental Energy (SHSE:603071), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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. The formula for this calculation on ZJMI Environmental Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = CN¥1.4b ÷ (CN¥10b - CN¥4.3b) (Based on the trailing twelve months to March 2023).
So, ZJMI Environmental Energy has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 15%.
Check out our latest analysis for ZJMI Environmental Energy
Above you can see how the current ROCE for ZJMI Environmental Energy compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering ZJMI Environmental Energy here for free.
What The Trend Of ROCE Can Tell Us
In terms of ZJMI Environmental Energy's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, four years ago it was 32%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 side note, ZJMI Environmental Energy has done well to pay down its current liabilities to 42% 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. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Bottom Line
From the above analysis, we find it rather worrisome that returns on capital and sales for ZJMI Environmental Energy have fallen, meanwhile the business is employing more capital than it was four years ago. And, the stock has remained flat over the last year, so investors don't seem too impressed either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a separate note, we've found 1 warning sign for ZJMI Environmental Energy you'll probably want to know about.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
