Jiangsu Guomao Reducer (SHSE:603915) Might Be Having Difficulty Using Its Capital Effectively

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at Jiangsu Guomao Reducer (SHSE:603915), it didn't seem to tick all of these boxes.

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. To calculate this metric for Jiangsu Guomao Reducer, this is the formula:

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

0.099 = CN¥369m ÷ (CN¥4.9b - CN¥1.2b) (Based on the trailing twelve months to March 2024).

Therefore, Jiangsu Guomao Reducer has an ROCE of 9.9%. On its own that's a low return, but compared to the average of 5.7% generated by the Machinery industry, it's much better.

Check out our latest analysis for Jiangsu Guomao Reducer

Above you can see how the current ROCE for Jiangsu Guomao Reducer 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 Jiangsu Guomao Reducer for free.

What Can We Tell From Jiangsu Guomao Reducer's ROCE Trend?

When we looked at the ROCE trend at Jiangsu Guomao Reducer, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Jiangsu Guomao Reducer has done well to pay down its current liabilities to 24% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Jiangsu Guomao Reducer's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 25% so the market doesn't look too hopeful on these trends strengthening any time soon. 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.

One more thing to note, we've identified 1 warning sign with Jiangsu Guomao Reducer and understanding it should be part of your investment process.

While Jiangsu Guomao Reducer 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.