The Returns On Capital At Chengdu Rainbow Appliance (Group) Shares (SZSE:003023) Don't Inspire Confidence

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 Chengdu Rainbow Appliance (Group) Shares (SZSE:003023), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Chengdu Rainbow Appliance (Group) Shares:

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

0.065 = CN¥96m ÷ (CN¥2.0b - CN¥572m) (Based on the trailing twelve months to September 2023).

So, Chengdu Rainbow Appliance (Group) Shares has an ROCE of 6.5%. In absolute terms, that's a low return but it's around the Consumer Durables industry average of 8.0%.

Check out our latest analysis for Chengdu Rainbow Appliance (Group) Shares

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

What Does the ROCE Trend For Chengdu Rainbow Appliance (Group) Shares Tell Us?

When we looked at the ROCE trend at Chengdu Rainbow Appliance (Group) Shares, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 6.5%. 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 side note, Chengdu Rainbow Appliance (Group) Shares has done well to pay down its current liabilities to 28% 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.

Our Take On Chengdu Rainbow Appliance (Group) Shares' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Chengdu Rainbow Appliance (Group) Shares. These growth trends haven't led to growth returns though, since the stock has fallen 27% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Chengdu Rainbow Appliance (Group) Shares does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored...

While Chengdu Rainbow Appliance (Group) Shares 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.