Be Wary Of Gongniu GroupLtd (SHSE:603195) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Looking at Gongniu GroupLtd (SHSE:603195), it does have a high ROCE right now, but lets see how returns are trending.

Understanding 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. The formula for this calculation on Gongniu GroupLtd is:

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

0.29 = CN¥3.9b ÷ (CN¥19b - CN¥5.1b) (Based on the trailing twelve months to September 2023).

Therefore, Gongniu GroupLtd has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Electrical industry average of 6.5%.

See our latest analysis for Gongniu GroupLtd

Above you can see how the current ROCE for Gongniu GroupLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Gongniu GroupLtd for free.

The Trend Of ROCE

On the surface, the trend of ROCE at Gongniu GroupLtd doesn't inspire confidence. Historically returns on capital were even higher at 60%, but they have dropped over the last five years. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Gongniu GroupLtd has decreased its current liabilities to 27% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Gongniu GroupLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Gongniu GroupLtd's reinvestment in its own business, we're aware that returns are shrinking. Additionally, the stock's total return to shareholders over the last three years has been flat, which isn't too surprising. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Like most companies, Gongniu GroupLtd does come with some risks, and we've found 1 warning sign that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.