To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Yuhuan CNC Machine ToolLtd (SZSE:002903), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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 Yuhuan CNC Machine ToolLtd:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = CN¥44m ÷ (CN¥1.1b - CN¥256m) (Based on the trailing twelve months to September 2023).
Thus, Yuhuan CNC Machine ToolLtd has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Machinery industry average of 6.1%.
View our latest analysis for Yuhuan CNC Machine ToolLtd
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 want to delve into the historical earnings, revenue and cash flow of Yuhuan CNC Machine ToolLtd, check out these free graphs here.
How Are Returns Trending?
On the surface, the trend of ROCE at Yuhuan CNC Machine ToolLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.5% from 8.6% 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.
What We Can Learn From Yuhuan CNC Machine ToolLtd's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Yuhuan CNC Machine ToolLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 54% return 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 5 warning signs with Yuhuan CNC Machine ToolLtd (at least 1 which is a bit unpleasant) , 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.
