What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after investigating Hangzhou Greenda Electronic Materials (SHSE:603931), we don't think it's current trends fit the mold of a multi-bagger.
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. Analysts use this formula to calculate it for Hangzhou Greenda Electronic Materials:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = CN¥158m ÷ (CN¥1.6b - CN¥180m) (Based on the trailing twelve months to September 2023).
So, Hangzhou Greenda Electronic Materials has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.5% it's much better.
See our latest analysis for Hangzhou Greenda Electronic Materials
In the above chart we have measured Hangzhou Greenda Electronic Materials' 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 Hangzhou Greenda Electronic Materials here for free.
What Can We Tell From Hangzhou Greenda Electronic Materials' ROCE Trend?
On the surface, the trend of ROCE at Hangzhou Greenda Electronic Materials doesn't inspire confidence. To be more specific, ROCE has fallen from 21% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a side note, Hangzhou Greenda Electronic Materials has done well to pay down its current liabilities to 11% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Key Takeaway
From the above analysis, we find it rather worrisome that returns on capital and sales for Hangzhou Greenda Electronic Materials have fallen, meanwhile the business is employing more capital than it was five years ago. But investors must be expecting an improvement of sorts because over the last three yearsthe stock has delivered a respectable 23% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Like most companies, Hangzhou Greenda Electronic Materials does come with some risks, and we've found 1 warning sign that you should be aware of.
While Hangzhou Greenda Electronic Materials 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.