There Are Reasons To Feel Uneasy About Zhongyan Technology's (SZSE:003001) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Zhongyan Technology (SZSE:003001), we don't think it's current trends fit the mold of a multi-bagger.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Zhongyan Technology, this is the formula:

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

0.024 = CN¥29m ÷ (CN¥1.8b - CN¥553m) (Based on the trailing twelve months to September 2024).

So, Zhongyan Technology has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.1%.

View our latest analysis for Zhongyan Technology

Above you can see how the current ROCE for Zhongyan Technology 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 Zhongyan Technology for free.

So How Is Zhongyan Technology's ROCE Trending?

When we looked at the ROCE trend at Zhongyan Technology, we didn't gain much confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 2.4%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Zhongyan Technology has decreased its current liabilities to 31% 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 Key Takeaway

In summary, we're somewhat concerned by Zhongyan Technology's diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 109% over the last three years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you want to continue researching Zhongyan Technology, you might be interested to know about the 1 warning sign 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.