What trends should we look for it we want to identify stocks that can 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Ningbo ZhongDa Leader Intelligent Transmission (SZSE:002896) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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 Ningbo ZhongDa Leader Intelligent Transmission:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = CN¥61m ÷ (CN¥1.6b - CN¥376m) (Based on the trailing twelve months to September 2023).
Thus, Ningbo ZhongDa Leader Intelligent Transmission has an ROCE of 5.1%. In absolute terms, that's a low return but it's around the Electrical industry average of 6.0%.
In the above chart we have measured Ningbo ZhongDa Leader Intelligent Transmission'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 Ningbo ZhongDa Leader Intelligent Transmission for free.
What The Trend Of ROCE Can Tell Us
Unfortunately, the trend isn't great with ROCE falling from 13% five years ago, while capital employed has grown 103%. That being said, Ningbo ZhongDa Leader Intelligent Transmission raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Ningbo ZhongDa Leader Intelligent Transmission might not have received a full period of earnings contribution from it. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.
On a related note, Ningbo ZhongDa Leader Intelligent Transmission has decreased its current liabilities to 24% 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 On Ningbo ZhongDa Leader Intelligent Transmission's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Ningbo ZhongDa Leader Intelligent Transmission. Furthermore the stock has climbed 94% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we've identified 1 warning sign with Ningbo ZhongDa Leader Intelligent Transmission and understanding this should be part of your investment process.
While Ningbo ZhongDa Leader Intelligent Transmission isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.