Chongqing Machinery & Electric's (HKG:2722) Returns Have Hit A Wall

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 Chongqing Machinery & Electric (HKG:2722), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 Chongqing Machinery & Electric, this is the formula:

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

0.0067 = CN¥69m ÷ (CN¥18b - CN¥7.6b) (Based on the trailing twelve months to June 2023).

Thus, Chongqing Machinery & Electric has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Industrials industry average of 2.5%.

See our latest analysis for Chongqing Machinery & Electric

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chongqing Machinery & Electric's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Chongqing Machinery & Electric, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

Over the past five years, Chongqing Machinery & Electric's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So don't be surprised if Chongqing Machinery & Electric doesn't end up being a multi-bagger in a few years time.

Another thing to note, Chongqing Machinery & Electric has a high ratio of current liabilities to total assets of 42%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In a nutshell, Chongqing Machinery & Electric has been trudging along with the same returns from the same amount of capital over the last five years. Since the stock has gained an impressive 52% over the last five 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 Chongqing Machinery & Electric, we've spotted 3 warning signs, and 1 of them is a bit unpleasant.

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.