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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Zhejiang Dafeng Industry (SHSE:603081) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. To calculate this metric for Zhejiang Dafeng Industry, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.03 = CN¥155m ÷ (CN¥8.1b - CN¥2.9b) (Based on the trailing twelve months to September 2023).
Therefore, Zhejiang Dafeng Industry has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 5.4%.
In the above chart we have measured Zhejiang Dafeng Industry's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Zhejiang Dafeng Industry here for free.
The Trend Of ROCE
In terms of Zhejiang Dafeng Industry's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 16%, but since then they've fallen to 3.0%. 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.
Our Take On Zhejiang Dafeng Industry's ROCE
Bringing it all together, while we're somewhat encouraged by Zhejiang Dafeng Industry's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 33% in the last five years. 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.
If you want to know some of the risks facing Zhejiang Dafeng Industry we've found 4 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.
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.
