Jiangsu Innovative Ecological New Materials (HKG:2116) Might Be Having Difficulty Using Its Capital Effectively

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. 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 Jiangsu Innovative Ecological New Materials (HKG:2116), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Jiangsu Innovative Ecological New Materials, this is the formula:

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

0.071 = CN¥22m ÷ (CN¥347m - CN¥34m) (Based on the trailing twelve months to December 2022).

Thus, Jiangsu Innovative Ecological New Materials has an ROCE of 7.1%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 15%.

View our latest analysis for Jiangsu Innovative Ecological New Materials

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 want to delve into the historical earnings, revenue and cash flow of Jiangsu Innovative Ecological New Materials, check out these free graphs here.

SWOT Analysis for Jiangsu Innovative Ecological New Materials

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Jiangsu Innovative Ecological New Materials doesn't inspire confidence. Around five years ago the returns on capital were 31%, but since then they've fallen to 7.1%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Jiangsu Innovative Ecological New Materials has done well to pay down its current liabilities to 9.7% 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.

Our Take On Jiangsu Innovative Ecological New Materials' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Jiangsu Innovative Ecological New Materials. However, despite the promising trends, the stock has fallen 49% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Jiangsu Innovative Ecological New Materials (of which 1 is potentially serious!) that you should know about.

While Jiangsu Innovative Ecological New Materials isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.