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Capital Allocation Trends At Zhongchao (NASDAQ:ZCMD) Aren't Ideal

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·2 min read
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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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.

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 Zhongchao is:

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

0.10 = US$3.5m ÷ (US$37m - US$3.6m) (Based on the trailing twelve months to June 2021).

Thus, Zhongchao has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 6.5% it's much better.

See our latest analysis for Zhongchao

roce
roce

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 Zhongchao, check out these free graphs here.

How Are Returns Trending?

In terms of Zhongchao's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 25% over the last three years. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Zhongchao is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 1.1% gain to shareholders who've held over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing: We've identified 2 warning signs with Zhongchao (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.