Will Zhengzhou Coal Mining Machinery Group's (HKG:564) Growth In ROCE Persist?

What trends should we look for it we want to identify stocks that can multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Zhengzhou Coal Mining Machinery Group (HKG:564) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What is it?

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 Zhengzhou Coal Mining Machinery Group, this is the formula:

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

0.15 = CN¥3.0b ÷ (CN¥32b - CN¥12b) (Based on the trailing twelve months to September 2020).

Thus, Zhengzhou Coal Mining Machinery Group has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 8.7% it's much better.

View our latest analysis for Zhengzhou Coal Mining Machinery Group

In the above chart we have measured Zhengzhou Coal Mining Machinery Group'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 report for Zhengzhou Coal Mining Machinery Group.

What The Trend Of ROCE Can Tell Us

We're delighted to see that Zhengzhou Coal Mining Machinery Group is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 15% on its capital. In addition to that, Zhengzhou Coal Mining Machinery Group is employing 106% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 39% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On Zhengzhou Coal Mining Machinery Group's ROCE

To the delight of most shareholders, Zhengzhou Coal Mining Machinery Group has now broken into profitability. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One more thing to note, we've identified 3 warning signs with Zhengzhou Coal Mining Machinery Group and understanding them should be part of your investment process.

While Zhengzhou Coal Mining Machinery Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. 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.
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