Damon Technology GroupLtd (SHSE:688360) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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 Damon Technology GroupLtd (SHSE:688360), it didn't seem to tick all of these boxes.

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. To calculate this metric for Damon Technology GroupLtd, this is the formula:

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

0.088 = CN¥101m ÷ (CN¥1.8b - CN¥684m) (Based on the trailing twelve months to December 2023).

Therefore, Damon Technology GroupLtd has an ROCE of 8.8%. On its own that's a low return, but compared to the average of 6.1% generated by the Machinery industry, it's much better.

Check out our latest analysis for Damon Technology GroupLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Damon Technology GroupLtd's ROCE against it's prior returns. If you'd like to look at how Damon Technology GroupLtd has performed in the past in other metrics, you can view this free graph of Damon Technology GroupLtd's past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Damon Technology GroupLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 8.8% from 20% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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, Damon Technology GroupLtd has decreased its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. 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

To conclude, we've found that Damon Technology GroupLtd is reinvesting in the business, but returns have been falling. And in the last three years, the stock has given away 26% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Damon Technology GroupLtd has the makings of a multi-bagger.

If you want to continue researching Damon Technology GroupLtd, you might be interested to know about the 2 warning signs that our analysis has discovered.

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.