Zhe Jiang Headman MachineryLtd (SHSE:688577) Will Be Hoping To Turn Its Returns On Capital Around

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after briefly looking over the numbers, we don't think Zhe Jiang Headman MachineryLtd (SHSE:688577) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhe Jiang Headman MachineryLtd, this is the formula:

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

0.032 = CN¥31m ÷ (CN¥1.3b - CN¥382m) (Based on the trailing twelve months to December 2023).

Thus, Zhe Jiang Headman MachineryLtd has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.1%.

Check out our latest analysis for Zhe Jiang Headman MachineryLtd

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'd like to look at how Zhe Jiang Headman MachineryLtd has performed in the past in other metrics, you can view this free graph of Zhe Jiang Headman MachineryLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 25% five years ago, while the business's capital employed increased by 235%. That being said, Zhe Jiang Headman MachineryLtd raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Zhe Jiang Headman MachineryLtd might not have received a full period of earnings contribution from it.

On a related note, Zhe Jiang Headman MachineryLtd has decreased its current liabilities to 29% 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. 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 Zhe Jiang Headman MachineryLtd is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 49% over the last three years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 3 warning signs we've spotted with Zhe Jiang Headman MachineryLtd (including 2 which don't sit too well with us) .

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.