Returns On Capital Signal Tricky Times Ahead For Zhejiang Zoenn Design (SZSE:300901)

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Zhejiang Zoenn Design (SZSE:300901) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Zhejiang Zoenn Design is:

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

0.019 = CN¥20m ÷ (CN¥1.2b - CN¥181m) (Based on the trailing twelve months to September 2023).

Thus, Zhejiang Zoenn Design has an ROCE of 1.9%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 5.5%.

Check out our latest analysis for Zhejiang Zoenn Design

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Zhejiang Zoenn Design, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.9% from 44% five years ago. 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 side note, Zhejiang Zoenn Design has done well to pay down its current liabilities to 15% 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.

What We Can Learn From Zhejiang Zoenn Design's ROCE

In summary, we're somewhat concerned by Zhejiang Zoenn Design's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 50% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 4 warning signs with Zhejiang Zoenn Design (at least 2 which make us uncomfortable) , and understanding them would certainly be useful.

While Zhejiang Zoenn Design 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.