There Are Reasons To Feel Uneasy About Changchun Zhiyuan New Energy Equipment's (SZSE:300985) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 investigating Changchun Zhiyuan New Energy Equipment (SZSE:300985), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Changchun Zhiyuan New Energy Equipment, this is the formula:

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

0.12 = CN¥223m ÷ (CN¥2.8b - CN¥975m) (Based on the trailing twelve months to June 2024).

Therefore, Changchun Zhiyuan New Energy Equipment has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 5.5% it's much better.

Check out our latest analysis for Changchun Zhiyuan New Energy Equipment

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

What Does the ROCE Trend For Changchun Zhiyuan New Energy Equipment Tell Us?

In terms of Changchun Zhiyuan New Energy Equipment's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 46%, but since then they've fallen to 12%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Changchun Zhiyuan New Energy Equipment has done well to pay down its current liabilities to 35% 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.

Our Take On Changchun Zhiyuan New Energy Equipment's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Changchun Zhiyuan New Energy Equipment is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 24% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Changchun Zhiyuan New Energy Equipment does come with some risks though, we found 4 warning signs in our investment analysis, and 3 of those are concerning...

While Changchun Zhiyuan New Energy Equipment isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.