Some Investors May Be Worried About China Railway Construction's (SHSE:601186) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at China Railway Construction (SHSE:601186) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for China Railway Construction:

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

0.062 = CN¥45b ÷ (CN¥1.8t - CN¥1.1t) (Based on the trailing twelve months to September 2024).

Therefore, China Railway Construction has an ROCE of 6.2%. Even though it's in line with the industry average of 6.1%, it's still a low return by itself.

See our latest analysis for China Railway Construction

In the above chart we have measured China Railway Construction'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 China Railway Construction for free.

So How Is China Railway Construction's ROCE Trending?

On the surface, the trend of ROCE at China Railway Construction doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.2% from 8.6% five years ago. However it looks like China Railway Construction 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.

On a separate but related note, it's important to know that China Railway Construction has a current liabilities to total assets ratio of 60%, which we'd consider pretty high. 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 Bottom Line

Bringing it all together, while we're somewhat encouraged by China Railway Construction's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 7.8% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing: We've identified 2 warning signs with China Railway Construction (at least 1 which is significant) , and understanding these would certainly be useful.

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.