Here's What's Concerning About Zhe Jiang Hai Liang's (SZSE:002203) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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 Zhe Jiang Hai Liang (SZSE:002203), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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 Zhe Jiang Hai Liang, this is the formula:

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

0.055 = CN¥1.5b ÷ (CN¥48b - CN¥21b) (Based on the trailing twelve months to June 2024).

So, Zhe Jiang Hai Liang has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 7.0%.

Check out our latest analysis for Zhe Jiang Hai Liang

In the above chart we have measured Zhe Jiang Hai Liang's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Zhe Jiang Hai Liang .

The Trend Of ROCE

In terms of Zhe Jiang Hai Liang's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.5% from 15% 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 related note, Zhe Jiang Hai Liang has decreased its current liabilities to 45% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Zhe Jiang Hai Liang's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 17% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Zhe Jiang Hai Liang has the makings of a multi-bagger.

On a final note, we found 2 warning signs for Zhe Jiang Hai Liang (1 makes us a bit uncomfortable) you should be aware of.

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.