Here's What's Concerning About Guangdong Deerma Technology's (SZSE:301332) 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? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Guangdong Deerma Technology (SZSE:301332) and its ROCE trend, we weren't exactly thrilled.

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 Guangdong Deerma Technology, this is the formula:

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

0.018 = CN¥51m ÷ (CN¥4.2b - CN¥1.3b) (Based on the trailing twelve months to March 2024).

Thus, Guangdong Deerma Technology has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 8.4%.

See our latest analysis for Guangdong Deerma Technology

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

What The Trend Of ROCE Can Tell Us

In terms of Guangdong Deerma Technology's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 12% over the last five years. However it looks like Guangdong Deerma Technology might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Guangdong Deerma Technology has done well to pay down its current liabilities to 32% 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Guangdong Deerma Technology's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 36% in the last year. Therefore based on the analysis done in this article, we don't think Guangdong Deerma Technology has the makings of a multi-bagger.

If you'd like to know about the risks facing Guangdong Deerma Technology, we've discovered 4 warning signs that you should be aware of.

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.

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