Returns On Capital At Fujian Longking (SHSE:600388) Paint A Concerning Picture

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Fujian Longking (SHSE:600388), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Fujian Longking:

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

0.079 = CN¥1.0b ÷ (CN¥25b - CN¥12b) (Based on the trailing twelve months to June 2024).

Therefore, Fujian Longking has an ROCE of 7.9%. In absolute terms, that's a low return, but it's much better than the Machinery industry average of 5.5%.

View our latest analysis for Fujian Longking

Above you can see how the current ROCE for Fujian Longking compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Fujian Longking .

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because Fujian Longking's ROCE has reduced by 51% over the last five years, while the business employed 111% more capital. Usually this isn't ideal, but given Fujian Longking conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Fujian Longking might not have received a full period of earnings contribution from it. Additionally, we found that Fujian Longking's most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.

On a related note, Fujian Longking has decreased its current liabilities to 48% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Fujian Longking's ROCE

We're a bit apprehensive about Fujian Longking because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 45% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Fujian Longking does have some risks though, and we've spotted 4 warning signs for Fujian Longking that you might be interested in.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.