There are a few key trends to look for if we want to identify the next multi-bagger. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at XTC New Energy Materials(Xiamen)Ltd (SHSE:688778) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. To calculate this metric for XTC New Energy Materials(Xiamen)Ltd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = CN¥492m ÷ (CN¥14b - CN¥4.6b) (Based on the trailing twelve months to March 2024).
Therefore, XTC New Energy Materials(Xiamen)Ltd has an ROCE of 5.0%. On its own, that's a low figure but it's around the 6.0% average generated by the Electrical industry.
In the above chart we have measured XTC New Energy Materials(Xiamen)Ltd's 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 analyst report for XTC New Energy Materials(Xiamen)Ltd .
What Does the ROCE Trend For XTC New Energy Materials(Xiamen)Ltd Tell Us?
When we looked at the ROCE trend at XTC New Energy Materials(Xiamen)Ltd, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.0% from 14% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a side note, XTC New Energy Materials(Xiamen)Ltd has done well to pay down its current liabilities to 32% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Key Takeaway
In summary, we're somewhat concerned by XTC New Energy Materials(Xiamen)Ltd's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last year have experienced a 29% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you'd like to know about the risks facing XTC New Energy Materials(Xiamen)Ltd, we've discovered 2 warning signs that you should be aware of.
While XTC New Energy Materials(Xiamen)Ltd 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.
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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.