Shanghai Construction Group's (SHSE:600170) Returns On Capital Not Reflecting Well On The Business

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Shanghai Construction Group (SHSE:600170), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Shanghai Construction Group:

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

0.042 = CN¥4.8b ÷ (CN¥360b - CN¥244b) (Based on the trailing twelve months to June 2024).

Thus, Shanghai Construction Group has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.1%.

See our latest analysis for Shanghai Construction Group

In the above chart we have measured Shanghai Construction Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanghai Construction Group for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Shanghai Construction Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.2% from 7.8% five years ago. However it looks like Shanghai Construction Group 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.

Another thing to note, Shanghai Construction Group has a high ratio of current liabilities to total assets of 68%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Shanghai Construction Group's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 14% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Shanghai Construction Group has the makings of a multi-bagger.

On a separate note, we've found 2 warning signs for Shanghai Construction Group you'll probably want to know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.