Here's What's Concerning About ZJMI Environmental Energy's (SHSE:603071) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So while ZJMI Environmental Energy (SHSE:603071) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. To calculate this metric for ZJMI Environmental Energy, this is the formula:

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

0.25 = CN¥1.5b ÷ (CN¥11b - CN¥5.1b) (Based on the trailing twelve months to September 2023).

Thus, ZJMI Environmental Energy has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 12%.

See our latest analysis for ZJMI Environmental Energy

In the above chart we have measured ZJMI Environmental Energy's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for ZJMI Environmental Energy .

What Does the ROCE Trend For ZJMI Environmental Energy Tell Us?

When we looked at the ROCE trend at ZJMI Environmental Energy, we didn't gain much confidence. While it's comforting that the ROCE is high, four years ago it was 31%. 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, ZJMI Environmental Energy has done well to pay down its current liabilities to 46% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.

Our Take On ZJMI Environmental Energy's ROCE

We're a bit apprehensive about ZJMI Environmental Energy because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 12% over the last year, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know more about ZJMI Environmental Energy, we've spotted 2 warning signs, and 1 of them makes us a bit uncomfortable.

ZJMI Environmental Energy is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.