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

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at China Baoan Group (SZSE:000009) 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 Baoan Group:

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

0.051 = CN¥1.9b ÷ (CN¥53b - CN¥16b) (Based on the trailing twelve months to September 2024).

Therefore, China Baoan Group has an ROCE of 5.1%. Ultimately, that's a low return and it under-performs the Industrials industry average of 6.4%.

Check out 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'd like to look at how China Baoan Group has performed in the past in other metrics, you can view this free graph of China Baoan Group's past earnings, revenue and cash flow.

So How Is China Baoan Group's ROCE Trending?

In terms of China Baoan Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 11%, but since then they've fallen to 5.1%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 related note, China Baoan Group has decreased its current liabilities to 30% 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. 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.

The Bottom Line

We're a bit apprehensive about China Baoan Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 22% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for China Baoan Group (of which 1 doesn't sit too well with us!) that you should know about.

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.