Be Wary Of Long Yuan Construction Group (SHSE:600491) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at Long Yuan Construction Group (SHSE:600491) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Long Yuan Construction Group is:

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

0.037 = CN¥1.1b ÷ (CN¥56b - CN¥27b) (Based on the trailing twelve months to June 2024).

Therefore, Long Yuan Construction Group has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Construction industry average of 5.7%.

Check out our latest analysis for Long Yuan Construction Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Long Yuan Construction Group's ROCE against it's prior returns. If you'd like to look at how Long Yuan Construction Group has performed in the past in other metrics, you can view this free graph of Long Yuan Construction Group's past earnings, revenue and cash flow.

What Can We Tell From Long Yuan Construction Group's ROCE Trend?

On the surface, the trend of ROCE at Long Yuan Construction Group doesn't inspire confidence. Around five years ago the returns on capital were 5.8%, but since then they've fallen to 3.7%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Long Yuan Construction Group has done well to pay down its current liabilities to 48% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Long Yuan Construction Group have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 64% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Like most companies, Long Yuan Construction Group does come with some risks, and we've found 2 warning signs that you should be aware of.

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.