Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. However, after investigating Renxin New MaterialLtd (SZSE:301395), we don't think it's current trends fit the mold of a multi-bagger.
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 Renxin New MaterialLtd:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = CN¥39m ÷ (CN¥1.9b - CN¥313m) (Based on the trailing twelve months to June 2024).
Thus, Renxin New MaterialLtd has an ROCE of 2.6%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.
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 Renxin New MaterialLtd has performed in the past in other metrics, you can view this free graph of Renxin New MaterialLtd's past earnings, revenue and cash flow.
What Does the ROCE Trend For Renxin New MaterialLtd Tell Us?
When we looked at the ROCE trend at Renxin New MaterialLtd, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.6% from 30% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, Renxin New MaterialLtd has done well to pay down its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From Renxin New MaterialLtd's ROCE
Bringing it all together, while we're somewhat encouraged by Renxin New MaterialLtd'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 19% in the last year. Therefore based on the analysis done in this article, we don't think Renxin New MaterialLtd has the makings of a multi-bagger.
Like most companies, Renxin New MaterialLtd does come with some risks, and we've found 3 warning signs that you should be aware of.
While Renxin New MaterialLtd 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.
