The Returns On Capital At Zhejiang Zhengguang Industrial (SZSE:301092) Don't Inspire Confidence

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. In light of that, when we looked at Zhejiang Zhengguang Industrial (SZSE:301092) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Zhejiang Zhengguang Industrial, this is the formula:

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

0.045 = CN¥84m ÷ (CN¥2.1b - CN¥220m) (Based on the trailing twelve months to September 2024).

Therefore, Zhejiang Zhengguang Industrial has an ROCE of 4.5%. On its own, that's a low figure but it's around the 5.6% average generated by the Chemicals industry.

See our latest analysis for Zhejiang Zhengguang Industrial

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Zhejiang Zhengguang Industrial has performed in the past in other metrics, you can view this free graph of Zhejiang Zhengguang Industrial's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Zhejiang Zhengguang Industrial, we didn't gain much confidence. Around five years ago the returns on capital were 30%, but since then they've fallen to 4.5%. However it looks like Zhejiang Zhengguang Industrial might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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 side note, Zhejiang Zhengguang Industrial has done well to pay down its current liabilities to 11% 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. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Zhejiang Zhengguang Industrial's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last three years has been flat. 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.

On a final note, we found 2 warning signs for Zhejiang Zhengguang Industrial (1 can't be ignored) 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.