Investors Met With Slowing Returns on Capital At Zhejiang Three Stars New Materials (SHSE:603578)

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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. That's why when we briefly looked at Zhejiang Three Stars New Materials' (SHSE:603578) ROCE trend, we were pretty happy with what we saw.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Zhejiang Three Stars New Materials is:

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

0.12 = CN¥133m ÷ (CN¥1.9b - CN¥828m) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Three Stars New Materials has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 6.4% generated by the Building industry.

Check out our latest analysis for Zhejiang Three Stars New Materials

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 Zhejiang Three Stars New Materials.

How Are Returns Trending?

While the returns on capital are good, they haven't moved much. The company has employed 103% more capital in the last five years, and the returns on that capital have remained stable at 12%. 12% is a pretty standard return, and it provides some comfort knowing that Zhejiang Three Stars New Materials has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 43% of total assets, this reported ROCE would probably be less than12% because total capital employed would be higher.The 12% ROCE could be even lower if current liabilities weren't 43% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

The Bottom Line On Zhejiang Three Stars New Materials' ROCE

In the end, Zhejiang Three Stars New Materials has proven its ability to adequately reinvest capital at good rates of return. However, over the last five years, the stock has only delivered a 14% return to shareholders who held over that period. So to determine if Zhejiang Three Stars New Materials is a multi-bagger going forward, we'd suggest digging deeper into the company's other fundamentals.

One more thing to note, we've identified 1 warning sign with Zhejiang Three Stars New Materials and understanding it should be part of your investment process.

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.