Returns On Capital At Zhen Ding Technology Holding (TPE:4958) Paint An Interesting Picture

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Although, when we looked at Zhen Ding Technology Holding (TPE:4958), it didn't seem to tick all of these boxes.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Zhen Ding Technology Holding is:

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

0.12 = NT$13b ÷ (NT$146b - NT$39b) (Based on the trailing twelve months to September 2020).

Thus, Zhen Ding Technology Holding has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Electronic industry average of 11%.

Check out our latest analysis for Zhen Ding Technology Holding

In the above chart we have measured Zhen Ding Technology Holding'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 Zhen Ding Technology Holding.

What Does the ROCE Trend For Zhen Ding Technology Holding Tell Us?

On the surface, the trend of ROCE at Zhen Ding Technology Holding doesn't inspire confidence. Over the last five years, returns on capital have decreased to 12% from 20% five years ago. However it looks like Zhen Ding Technology Holding might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Zhen Ding Technology Holding has done well to pay down its current liabilities to 26% 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

To conclude, we've found that Zhen Ding Technology Holding is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 105% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you'd like to know about the risks facing Zhen Ding Technology Holding, we've discovered 2 warning signs that you should be aware of.

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