Be Wary Of Dongguan Aohai Technology (SZSE:002993) And Its Returns On Capital

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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 briefly looking over the numbers, we don't think Dongguan Aohai Technology (SZSE:002993) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Dongguan Aohai Technology is:

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

0.075 = CN¥395m ÷ (CN¥8.5b - CN¥3.3b) (Based on the trailing twelve months to June 2024).

Therefore, Dongguan Aohai Technology has an ROCE of 7.5%. On its own that's a low return, but compared to the average of 5.6% generated by the Tech industry, it's much better.

View our latest analysis for Dongguan Aohai Technology

In the above chart we have measured Dongguan Aohai Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Dongguan Aohai Technology .

The Trend Of ROCE

When we looked at the ROCE trend at Dongguan Aohai Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.5% from 24% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Dongguan Aohai Technology has done well to pay down its current liabilities to 39% 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. 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

In summary, despite lower returns in the short term, we're encouraged to see that Dongguan Aohai Technology is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 17% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One final note, you should learn about the 2 warning signs we've spotted with Dongguan Aohai Technology (including 1 which can't be ignored) .

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.