Investors Could Be Concerned With Shanghai Tunnel Engineering's (SHSE:600820) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. In light of that, when we looked at Shanghai Tunnel Engineering (SHSE:600820) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. To calculate this metric for Shanghai Tunnel Engineering, this is the formula:

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

0.028 = CN¥1.9b ÷ (CN¥164b - CN¥96b) (Based on the trailing twelve months to September 2024).

Therefore, Shanghai Tunnel Engineering has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.1%.

Check out our latest analysis for Shanghai Tunnel Engineering

Above you can see how the current ROCE for Shanghai Tunnel Engineering compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Shanghai Tunnel Engineering .

The Trend Of ROCE

On the surface, the trend of ROCE at Shanghai Tunnel Engineering doesn't inspire confidence. To be more specific, ROCE has fallen from 5.0% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Shanghai Tunnel Engineering's current liabilities have increased over the last five years to 59% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.8%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From Shanghai Tunnel Engineering's ROCE

To conclude, we've found that Shanghai Tunnel Engineering is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 35% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Shanghai Tunnel Engineering (of which 1 is a bit unpleasant!) that you should 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.