Investors Could Be Concerned With Zhongchao's (NASDAQ:ZCMD) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Zhongchao (NASDAQ:ZCMD), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

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 Zhongchao is:

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

0.14 = US$4.5m ÷ (US$35m - US$3.0m) (Based on the trailing twelve months to December 2020).

So, Zhongchao has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 8.2% generated by the Consumer Services industry.

Check out our latest analysis for Zhongchao

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're interested in investigating Zhongchao's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Zhongchao's ROCE Trending?

When we looked at the ROCE trend at Zhongchao, we didn't gain much confidence. Around three years ago the returns on capital were 19%, but since then they've fallen to 14%. 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 related note, Zhongchao has decreased its current liabilities to 8.6% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Zhongchao's 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 Zhongchao. In light of this, the stock has only gained 2.3% over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Zhongchao does have some risks, we noticed 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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.

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.

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