Be Wary Of Xuchang KETOP Testing Research InstituteLtd (SZSE:003008) And Its Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Xuchang KETOP Testing Research InstituteLtd (SZSE:003008), we don't think it's current trends fit the mold of a multi-bagger.

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

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. The formula for this calculation on Xuchang KETOP Testing Research InstituteLtd is:

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

0.055 = CN¥59m ÷ (CN¥1.1b - CN¥66m) (Based on the trailing twelve months to September 2023).

Therefore, Xuchang KETOP Testing Research InstituteLtd has an ROCE of 5.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.9%.

Check out our latest analysis for Xuchang KETOP Testing Research InstituteLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Xuchang KETOP Testing Research InstituteLtd's ROCE against it's prior returns. If you're interested in investigating Xuchang KETOP Testing Research InstituteLtd's past further, check out this free graph covering Xuchang KETOP Testing Research InstituteLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Xuchang KETOP Testing Research InstituteLtd, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.5% from 43% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Xuchang KETOP Testing Research InstituteLtd has decreased its current liabilities to 5.9% of total assets. So we could link some of this to the decrease in ROCE. 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.

What We Can Learn From Xuchang KETOP Testing Research InstituteLtd's ROCE

While returns have fallen for Xuchang KETOP Testing Research InstituteLtd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 49% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you'd like to know more about Xuchang KETOP Testing Research InstituteLtd, we've spotted 2 warning signs, and 1 of them is concerning.

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.