If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Hunan Sokan New Materials (SHSE:688157), 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. The formula for this calculation on Hunan Sokan New Materials is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = CN¥53m ÷ (CN¥1.5b - CN¥175m) (Based on the trailing twelve months to September 2023).
So, Hunan Sokan New Materials has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.
View our latest analysis for Hunan Sokan New Materials
In the above chart we have measured Hunan Sokan New Materials' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Hunan Sokan New Materials.
What Can We Tell From Hunan Sokan New Materials' ROCE Trend?
On the surface, the trend of ROCE at Hunan Sokan New Materials doesn't inspire confidence. To be more specific, ROCE has fallen from 14% over the last five years. 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 may take some time before the company starts to see any change in earnings from these investments.
On a side note, Hunan Sokan New Materials has done well to pay down its current liabilities to 12% 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.
In Conclusion...
To conclude, we've found that Hunan Sokan New Materials is reinvesting in the business, but returns have been falling. Additionally, the stock's total return to shareholders over the last three years has been flat, which isn't too surprising. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Like most companies, Hunan Sokan New Materials does come with some risks, and we've found 1 warning sign that you should be aware of.
While Hunan Sokan New Materials 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.