What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So when we looked at Shenzhen Gongjin Electronics (SHSE:603118) and its trend of ROCE, we really liked what we saw.
What Is 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 Shenzhen Gongjin Electronics is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = CN¥307m ÷ (CN¥11b - CN¥5.0b) (Based on the trailing twelve months to September 2023).
Therefore, Shenzhen Gongjin Electronics has an ROCE of 5.4%. On its own that's a low return, but compared to the average of 4.4% generated by the Communications industry, it's much better.
In the above chart we have measured Shenzhen Gongjin Electronics' 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 Shenzhen Gongjin Electronics .
How Are Returns Trending?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. The data shows that returns on capital have increased substantially over the last five years to 5.4%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 26%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
Another thing to note, Shenzhen Gongjin Electronics has a high ratio of current liabilities to total assets of 47%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Shenzhen Gongjin Electronics' ROCE
To sum it up, Shenzhen Gongjin Electronics has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Given the stock has declined 24% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
Shenzhen Gongjin Electronics does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should know about.
While Shenzhen Gongjin Electronics 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.