If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Kunshan Dongwei TechnologyLtd (SHSE:688700) and its ROCE trend, we weren't exactly thrilled.
What Is Return On Capital Employed (ROCE)?
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 Kunshan Dongwei TechnologyLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = CN¥113m ÷ (CN¥2.4b - CN¥565m) (Based on the trailing twelve months to March 2024).
So, Kunshan Dongwei TechnologyLtd has an ROCE of 6.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.6%.
In the above chart we have measured Kunshan Dongwei TechnologyLtd's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Kunshan Dongwei TechnologyLtd .
So How Is Kunshan Dongwei TechnologyLtd's ROCE Trending?
When we looked at the ROCE trend at Kunshan Dongwei TechnologyLtd, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.3% from 36% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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, Kunshan Dongwei TechnologyLtd has done well to pay down its current liabilities to 24% of total assets. So we could link some of this to the decrease in ROCE. 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.
Our Take On Kunshan Dongwei TechnologyLtd's ROCE
In summary, we're somewhat concerned by Kunshan Dongwei TechnologyLtd's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 26% return over the last three years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you'd like to know more about Kunshan Dongwei TechnologyLtd, we've spotted 3 warning signs, and 1 of them doesn't sit too well with us.
While Kunshan Dongwei TechnologyLtd 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.
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