Zhejiang Gongdong Medical Technology (SHSE:605369) Is Reinvesting At Lower Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Zhejiang Gongdong Medical Technology (SHSE:605369), 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 Zhejiang Gongdong Medical Technology is:

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

0.057 = CN¥93m ÷ (CN¥1.9b - CN¥241m) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Gongdong Medical Technology has an ROCE of 5.7%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 8.2%.

See our latest analysis for Zhejiang Gongdong Medical Technology

In the above chart we have measured Zhejiang Gongdong Medical Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Zhejiang Gongdong Medical Technology for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Zhejiang Gongdong Medical Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.7% from 27% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Zhejiang Gongdong Medical Technology has decreased its current liabilities to 13% of total assets. That could partly explain why the ROCE has dropped. 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.

Our Take On Zhejiang Gongdong Medical Technology's ROCE

We're a bit apprehensive about Zhejiang Gongdong Medical Technology because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 0.2% over the last three years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a final note, we've found 2 warning signs for Zhejiang Gongdong Medical Technology that we think you should be aware of.

While Zhejiang Gongdong Medical Technology may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.