Returns On Capital Signal Tricky Times Ahead For Damon Technology GroupLtd (SHSE:688360)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Damon Technology GroupLtd (SHSE:688360) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Damon Technology GroupLtd is:

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

0.068 = CN¥118m ÷ (CN¥2.7b - CN¥1b) (Based on the trailing twelve months to September 2024).

Therefore, Damon Technology GroupLtd has an ROCE of 6.8%. On its own that's a low return, but compared to the average of 5.2% generated by the Machinery industry, it's much better.

View 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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Damon Technology GroupLtd.

What Can We Tell From Damon Technology GroupLtd's ROCE Trend?

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 6.8% from 19% five years ago. 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 related note, Damon Technology GroupLtd has decreased its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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...

To conclude, we've found that Damon Technology GroupLtd is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 23% over the last three years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know about the risks facing Damon Technology GroupLtd, we've discovered 2 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.