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

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 briefly looking over the numbers, we don't think Fujian Kuncai Material Technology (SHSE:603826) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Fujian Kuncai Material Technology is:

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

0.058 = CN¥155m ÷ (CN¥4.7b - CN¥2.0b) (Based on the trailing twelve months to June 2024).

So, Fujian Kuncai Material Technology has an ROCE of 5.8%. In absolute terms, that's a low return but it's around the Chemicals industry average of 5.5%.

View our latest analysis for Fujian Kuncai Material Technology

Above you can see how the current ROCE for Fujian Kuncai Material Technology compares to its prior returns on capital, but there's only so much you can tell from the past. 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 .

The Trend Of ROCE

When we looked at the ROCE trend at Fujian Kuncai Material Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.8% from 12% five 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Fujian Kuncai Material Technology's current liabilities have increased over the last five years to 43% 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. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

What We Can Learn From Fujian Kuncai Material Technology's ROCE

Bringing it all together, while we're somewhat encouraged by Fujian Kuncai Material Technology's reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 173% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 1 warning sign with Fujian Kuncai Material Technology and understanding this should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.