There Are Reasons To Feel Uneasy About Fujian Kuncai Material Technology's (SHSE:603826) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Having said that, from a first glance at Fujian Kuncai Material Technology (SHSE:603826) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Fujian Kuncai Material Technology, this is the formula:

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

0.037 = CN¥104m ÷ (CN¥4.1b - CN¥1.4b) (Based on the trailing twelve months to September 2023).

Therefore, Fujian Kuncai Material Technology has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.8%.

Check out our latest analysis for Fujian Kuncai Material Technology

In the above chart we have measured Fujian Kuncai Material Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Fujian Kuncai Material Technology .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Fujian Kuncai Material Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.8% from 13% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Fujian Kuncai Material Technology's current liabilities have increased over the last five years to 33% of total assets, effectively distorting the ROCE to some degree. 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 Fujian Kuncai Material Technology's ROCE

In summary, Fujian Kuncai Material Technology is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 156% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Fujian Kuncai Material Technology does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is concerning...

While Fujian Kuncai Material 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.