GCH Technology (SHSE:688625) Might Be Having Difficulty Using Its Capital Effectively

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 briefly looking over the numbers, we don't think GCH Technology (SHSE:688625) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 GCH Technology, this is the formula:

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

0.17 = CN¥215m ÷ (CN¥3.0b - CN¥1.7b) (Based on the trailing twelve months to September 2023).

Thus, GCH Technology has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 5.8% generated by the Chemicals industry.

See our latest analysis for GCH Technology

Above you can see how the current ROCE for GCH 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 GCH Technology .

How Are Returns Trending?

Unfortunately, the trend isn't great with ROCE falling from 34% five years ago, while capital employed has grown 557%. Usually this isn't ideal, but given GCH Technology conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence GCH Technology might not have received a full period of earnings contribution from it.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 58%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 17%. 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.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that GCH Technology is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 16% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for GCH Technology (of which 1 is concerning!) that you should know about.

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.