What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Shanghai Sanyou Medical (SHSE:688085), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shanghai Sanyou Medical, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.078 = CN¥157m ÷ (CN¥2.2b - CN¥215m) (Based on the trailing twelve months to June 2023).
So, Shanghai Sanyou Medical has an ROCE of 7.8%. On its own, that's a low figure but it's around the 9.6% average generated by the Medical Equipment industry.
See our latest analysis for Shanghai Sanyou Medical
Above you can see how the current ROCE for Shanghai Sanyou Medical compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
On the surface, the trend of ROCE at Shanghai Sanyou Medical doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.8% from 10% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line
To conclude, we've found that Shanghai Sanyou Medical is reinvesting in the business, but returns have been falling. Since the stock has declined 52% over the last three years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
One more thing to note, we've identified 2 warning signs with Shanghai Sanyou Medical and understanding them should be part of your investment process.
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.