Essence Fastening Systems (Shanghai) (SZSE:301005) Is Reinvesting At Lower Rates Of Return

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Essence Fastening Systems (Shanghai) (SZSE:301005) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. To calculate this metric for Essence Fastening Systems (Shanghai), this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.0038 = CN¥3.1m ÷ (CN¥1.2b - CN¥371m) (Based on the trailing twelve months to September 2024).

So, Essence Fastening Systems (Shanghai) has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 6.9%.

See our latest analysis for Essence Fastening Systems (Shanghai)

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Essence Fastening Systems (Shanghai).

The Trend Of ROCE

When we looked at the ROCE trend at Essence Fastening Systems (Shanghai), we didn't gain much confidence. Around five years ago the returns on capital were 24%, but since then they've fallen to 0.4%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line

While returns have fallen for Essence Fastening Systems (Shanghai) in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 6.5% over the last three years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One more thing: We've identified 4 warning signs with Essence Fastening Systems (Shanghai) (at least 1 which is concerning) , and understanding these would certainly be useful.

While Essence Fastening Systems (Shanghai) 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.