Be Wary Of Zhejiang Runyang New Material Technology (SZSE:300920) And Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. Having said that, from a first glance at Zhejiang Runyang New Material Technology (SZSE:300920) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 Zhejiang Runyang New Material Technology is:

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

0.03 = CN¥36m ÷ (CN¥1.3b - CN¥109m) (Based on the trailing twelve months to December 2023).

Thus, Zhejiang Runyang New Material Technology has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.8%.

View our latest analysis for Zhejiang Runyang New Material Technology

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

The Trend Of ROCE

On the surface, the trend of ROCE at Zhejiang Runyang New Material Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.0% from 36% 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, Zhejiang Runyang New Material Technology has done well to pay down its current liabilities to 8.2% 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 Key Takeaway

Bringing it all together, while we're somewhat encouraged by Zhejiang Runyang New Material Technology's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 58% over the last three years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing to note, we've identified 2 warning signs with Zhejiang Runyang New Material Technology and understanding them 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.