There Are Reasons To Feel Uneasy About Zhejiang Jinghua Laser TechnologyLtd's (SHSE:603607) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Zhejiang Jinghua Laser TechnologyLtd (SHSE:603607), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 Zhejiang Jinghua Laser TechnologyLtd, this is the formula:

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

0.069 = CN¥68m ÷ (CN¥1.4b - CN¥458m) (Based on the trailing twelve months to September 2023).

Thus, Zhejiang Jinghua Laser TechnologyLtd has an ROCE of 6.9%. On its own that's a low return, but compared to the average of 3.8% generated by the Forestry industry, it's much better.

View our latest analysis for Zhejiang Jinghua Laser TechnologyLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Zhejiang Jinghua Laser TechnologyLtd has performed in the past in other metrics, you can view this free graph of Zhejiang Jinghua Laser TechnologyLtd's past earnings, revenue and cash flow.

So How Is Zhejiang Jinghua Laser TechnologyLtd's ROCE Trending?

When we looked at the ROCE trend at Zhejiang Jinghua Laser TechnologyLtd, we didn't gain much confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 6.9%. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line On Zhejiang Jinghua Laser TechnologyLtd's ROCE

In summary, we're somewhat concerned by Zhejiang Jinghua Laser TechnologyLtd's diminishing returns on increasing amounts of capital. In spite of that, the stock has delivered a 7.2% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing: We've identified 2 warning signs with Zhejiang Jinghua Laser TechnologyLtd (at least 1 which is concerning) , and understanding these would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.