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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Although, when we looked at Zhongchao (NASDAQ:ZCMD), it didn't seem to tick all of these boxes.
Understanding 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. To calculate this metric for Zhongchao, this is the formula:
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).
Therefore, Zhongchao has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 8.1% generated by the Consumer Services industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhongchao's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Zhongchao, check out these free graphs here.
What Does the ROCE Trend For Zhongchao Tell Us?
In terms of Zhongchao's historical ROCE movements, the trend isn't fantastic. Around three years ago the returns on capital were 19%, but since then they've fallen to 14%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Zhongchao has done well to pay down its current liabilities to 8.6% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.
The Key Takeaway
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. And there could be an opportunity here if other metrics look good too, because the stock has declined 29% in the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
On a final note, we found 2 warning signs for Zhongchao (1 is concerning) you should be aware of.
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. 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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