Zhejiang Three Stars New Materials' (SHSE:603578) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Zhejiang Three Stars New Materials (SHSE:603578) and its ROCE trend, we weren't exactly thrilled.

What Is 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. 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)

0.023 = CN¥66m ÷ (CN¥4.3b - CN¥1.5b) (Based on the trailing twelve months to June 2024).

So, Zhejiang Three Stars New Materials has an ROCE of 2.3%. In absolute terms, that's a low return and it also under-performs the Building industry average of 7.5%.

View 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.

So How Is Zhejiang Three Stars New Materials' ROCE Trending?

In terms of Zhejiang Three Stars New Materials' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.3% from 9.0% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Zhejiang Three Stars New Materials' current liabilities have increased over the last five years to 34% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.3%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

What We Can Learn From Zhejiang Three Stars New Materials' ROCE

In summary, we're somewhat concerned by Zhejiang Three Stars New Materials' diminishing returns on increasing amounts of capital. In spite of that, the stock has delivered a 32% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

If you'd like to know more about Zhejiang Three Stars New Materials, we've spotted 4 warning signs, and 1 of them is a bit concerning.

While Zhejiang Three Stars New Materials 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.