Investors Could Be Concerned With Cathay Biotech's (SHSE:688065) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Although, when we looked at Cathay Biotech (SHSE:688065), it didn't seem to tick all of these boxes.

What Is 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. The formula for this calculation on Cathay Biotech is:

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

0.02 = CN¥316m ÷ (CN¥18b - CN¥2.4b) (Based on the trailing twelve months to September 2024).

So, Cathay Biotech has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.

See our latest analysis for Cathay Biotech

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cathay Biotech's ROCE against it's prior returns. If you're interested in investigating Cathay Biotech's past further, check out this free graph covering Cathay Biotech's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Cathay Biotech's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.0% from 12% five years ago. 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.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Cathay Biotech. And there could be an opportunity here if other metrics look good too, because the stock has declined 53% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a separate note, we've found 1 warning sign for Cathay Biotech you'll probably want to know about.

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.