If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 ChangZhou KAIDI Electrical (SHSE:605288) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on ChangZhou KAIDI Electrical is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0086 = CN¥19m ÷ (CN¥2.6b - CN¥457m) (Based on the trailing twelve months to June 2023).
Thus, ChangZhou KAIDI Electrical has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.3%.
View our latest analysis for ChangZhou KAIDI Electrical
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 ChangZhou KAIDI Electrical has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at ChangZhou KAIDI Electrical doesn't inspire confidence. To be more specific, ROCE has fallen from 44% 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, ChangZhou KAIDI Electrical has done well to pay down its current liabilities to 17% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On ChangZhou KAIDI Electrical's ROCE
In summary, we're somewhat concerned by ChangZhou KAIDI Electrical's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 48% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing: We've identified 2 warning signs with ChangZhou KAIDI Electrical (at least 1 which can't be ignored) , and understanding them would certainly be useful.
While ChangZhou KAIDI Electrical 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.