Shanghai Geoharbour Construction Group's (SHSE:605598) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. In light of that, when we looked at Shanghai Geoharbour Construction Group (SHSE:605598) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Shanghai Geoharbour Construction Group is:

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

0.091 = CN¥173m ÷ (CN¥2.3b - CN¥398m) (Based on the trailing twelve months to September 2024).

Thus, Shanghai Geoharbour Construction Group has an ROCE of 9.1%. On its own that's a low return, but compared to the average of 6.1% generated by the Construction industry, it's much better.

Check out our latest analysis for Shanghai Geoharbour Construction Group

In the above chart we have measured Shanghai Geoharbour 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 Geoharbour Construction Group for free.

What Can We Tell From Shanghai Geoharbour Construction Group's ROCE Trend?

In terms of Shanghai Geoharbour Construction Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 9.1% from 21% five years ago. 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, Shanghai Geoharbour Construction Group has done well to pay down its current liabilities to 17% 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. 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.

What We Can Learn From Shanghai Geoharbour Construction Group's ROCE

While returns have fallen for Shanghai Geoharbour Construction Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 104% to shareholders in the last three years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you'd like to know more about Shanghai Geoharbour Construction Group, we've spotted 3 warning signs, and 1 of them is concerning.

While Shanghai Geoharbour Construction Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.