If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Zhejiang Huada New Materials (SHSE:605158) 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)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Zhejiang Huada New Materials is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.073 = CN¥173m ÷ (CN¥5.4b - CN¥3.0b) (Based on the trailing twelve months to September 2023).
So, Zhejiang Huada New Materials has an ROCE of 7.3%. In absolute terms, that's a low return but it's around the Metals and Mining industry average of 6.3%.
See our latest analysis for Zhejiang Huada New Materials
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're interested in investigating Zhejiang Huada New Materials' past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
In terms of Zhejiang Huada New Materials' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.3% from 22% five years ago. 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.
Another thing to note, Zhejiang Huada New Materials has a high ratio of current liabilities to total assets of 56%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Zhejiang Huada New Materials' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Huada New Materials have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 17% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you want to continue researching Zhejiang Huada New Materials, you might be interested to know about the 1 warning sign that our analysis has discovered.
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.