Zhejiang Chengchang Technology (SZSE:001270) Will Be Hoping To Turn Its Returns On Capital Around

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Zhejiang Chengchang Technology (SZSE:001270), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Zhejiang Chengchang Technology is:

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

0.021 = CN¥30m ÷ (CN¥1.4b - CN¥27m) (Based on the trailing twelve months to March 2024).

Thus, Zhejiang Chengchang Technology has an ROCE of 2.1%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 4.2%.

View our latest analysis for Zhejiang Chengchang Technology

Above you can see how the current ROCE for Zhejiang Chengchang Technology 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 Zhejiang Chengchang Technology for free.

So How Is Zhejiang Chengchang Technology's ROCE Trending?

In terms of Zhejiang Chengchang Technology's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 30%, but since then they've fallen to 2.1%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Zhejiang Chengchang Technology has done well to pay down its current liabilities to 1.9% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

The Key Takeaway

In summary, we're somewhat concerned by Zhejiang Chengchang Technology's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 50% over the last year, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Zhejiang Chengchang Technology (of which 1 doesn't sit too well with us!) 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.