China Baoan Group (SZSE:000009) Could Be Struggling To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after investigating China Baoan Group (SZSE:000009), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for China Baoan Group:

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

0.067 = CN¥2.5b ÷ (CN¥52b - CN¥15b) (Based on the trailing twelve months to March 2024).

Thus, China Baoan Group has an ROCE of 6.7%. In absolute terms, that's a low return but it's around the Industrials industry average of 6.3%.

See our latest analysis for China Baoan Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Baoan Group's ROCE against it's prior returns. If you're interested in investigating China Baoan Group's past further, check out this free graph covering China Baoan Group's past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at China Baoan Group doesn't inspire confidence. Around five years ago the returns on capital were 8.6%, but since then they've fallen to 6.7%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, China Baoan Group has decreased its current liabilities to 29% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

In summary, we're somewhat concerned by China Baoan Group's diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 106%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

China Baoan Group does have some risks though, and we've spotted 1 warning sign for China Baoan Group that you might be interested in.

While China Baoan Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.