What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Guangzhou Kingmed Diagnostics Group (SHSE:603882), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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. Analysts use this formula to calculate it for Guangzhou Kingmed Diagnostics Group:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.069 = CN¥640m ÷ (CN¥12b - CN¥2.9b) (Based on the trailing twelve months to September 2023).

So, Guangzhou Kingmed Diagnostics Group has an ROCE of 6.9%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 11%.

See our latest analysis for Guangzhou Kingmed Diagnostics Group

Above you can see how the current ROCE for Guangzhou Kingmed Diagnostics Group 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.

So How Is Guangzhou Kingmed Diagnostics Group's ROCE Trending?

When we looked at the ROCE trend at Guangzhou Kingmed Diagnostics Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.9% from 11% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Guangzhou Kingmed Diagnostics Group has done well to pay down its current liabilities to 24% 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.

In Conclusion...

In summary, we're somewhat concerned by Guangzhou Kingmed Diagnostics Group's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 228% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing: We've identified 2 warning signs with Guangzhou Kingmed Diagnostics Group (at least 1 which can't be ignored) , and understanding these would certainly be useful.

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.