Zhejiang Dragon Technology (SHSE:603004) Is Reinvesting At Lower Rates Of Return

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Zhejiang Dragon Technology (SHSE:603004) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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. Analysts use this formula to calculate it for Zhejiang Dragon Technology:

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

0.089 = CN¥173m ÷ (CN¥2.1b - CN¥169m) (Based on the trailing twelve months to September 2024).

So, Zhejiang Dragon Technology has an ROCE of 8.9%. On its own that's a low return, but compared to the average of 5.5% generated by the Chemicals industry, it's much better.

View our latest analysis for Zhejiang Dragon Technology

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

What Can We Tell From Zhejiang Dragon Technology's ROCE Trend?

On the surface, the trend of ROCE at Zhejiang Dragon Technology doesn't inspire confidence. Over the last four years, returns on capital have decreased to 8.9% from 26% four years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Zhejiang Dragon Technology has decreased its current liabilities to 8.0% 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 Dragon Technology's ROCE

In summary, Zhejiang Dragon Technology is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 49% in the last year. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

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

While Zhejiang Dragon 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.