Investors Could Be Concerned With Nanjing COSMOS Chemical's (SZSE:300856) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. So while Nanjing COSMOS Chemical (SZSE:300856) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. The formula for this calculation on Nanjing COSMOS Chemical is:

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

0.22 = CN¥784m ÷ (CN¥4.0b - CN¥396m) (Based on the trailing twelve months to September 2024).

Thus, Nanjing COSMOS Chemical has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 5.5% earned by companies in a similar industry.

Check out our latest analysis for Nanjing COSMOS Chemical

Above you can see how the current ROCE for Nanjing COSMOS Chemical compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Nanjing COSMOS Chemical for free.

What Does the ROCE Trend For Nanjing COSMOS Chemical Tell Us?

In terms of Nanjing COSMOS Chemical's historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 33% where it was 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, Nanjing COSMOS Chemical has done well to pay down its current liabilities to 9.9% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Nanjing COSMOS Chemical's ROCE

Bringing it all together, while we're somewhat encouraged by Nanjing COSMOS Chemical's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 48% over the last three years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know more about Nanjing COSMOS Chemical, we've spotted 2 warning signs, and 1 of them shouldn't be ignored.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.