Red Avenue New Materials Group (SHSE:603650) Will Be Hoping To Turn Its Returns On Capital Around

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Red Avenue New Materials Group (SHSE:603650), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Red Avenue New Materials Group is:

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

0.048 = CN¥282m ÷ (CN¥7.8b - CN¥1.9b) (Based on the trailing twelve months to June 2024).

Thus, Red Avenue New Materials Group has an ROCE of 4.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.5%.

Check out our latest analysis for Red Avenue New Materials Group

Above you can see how the current ROCE for Red Avenue New Materials Group 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 Red Avenue New Materials Group for free.

What Does the ROCE Trend For Red Avenue New Materials Group Tell Us?

When we looked at the ROCE trend at Red Avenue New Materials Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 20% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Red Avenue New Materials Group has done well to pay down its current liabilities to 25% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Red Avenue New Materials Group's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Red Avenue New Materials Group. And the stock has followed suit returning a meaningful 58% to shareholders over the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

On a separate note, we've found 2 warning signs for Red Avenue New Materials Group you'll probably want to know about.

While Red Avenue New Materials Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.