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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Dashang (SHSE:600694) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Dashang is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = CN¥877m ÷ (CN¥18b - CN¥6.1b) (Based on the trailing twelve months to September 2023).
So, Dashang has an ROCE of 7.2%. On its own that's a low return, but compared to the average of 4.3% generated by the Multiline Retail industry, it's much better.
In the above chart we have measured Dashang'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 Dashang for free.
The Trend Of ROCE
When we looked at the ROCE trend at Dashang, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.2% from 15% 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 may take some time before the company starts to see any change in earnings from these investments.
On a related note, Dashang has decreased its current liabilities to 33% 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.
The Bottom Line On Dashang's ROCE
Bringing it all together, while we're somewhat encouraged by Dashang's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 32% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
One more thing to note, we've identified 1 warning sign with Dashang and understanding this should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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.