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. In light of that, when we looked at Nanjing Toua Hardware and Tools (SZSE:301125) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Nanjing Toua Hardware and Tools is:

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

0.039 = CN¥31m ÷ (CN¥1.0b - CN¥227m) (Based on the trailing twelve months to September 2023).

Therefore, Nanjing Toua Hardware and Tools has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.1%.

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 Nanjing Toua Hardware and Tools has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Nanjing Toua Hardware and Tools' ROCE Trend?

In terms of Nanjing Toua Hardware and Tools' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 41%, but since then they've fallen to 3.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Nanjing Toua Hardware and Tools has decreased its current liabilities to 22% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

The Bottom Line

To conclude, we've found that Nanjing Toua Hardware and Tools is reinvesting in the business, but returns have been falling. Since the stock has declined 29% over the last year, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

On a separate note, we've found 3 warning signs for Nanjing Toua Hardware and Tools you'll probably want to know about.

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.