There Are Reasons To Feel Uneasy About Guangxi Liugong Machinery's (SZSE:000528) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Although, when we looked at Guangxi Liugong Machinery (SZSE:000528), it didn't seem to tick all of these boxes.

What Is 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 Guangxi Liugong Machinery:

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

0.058 = CN¥1.4b ÷ (CN¥46b - CN¥22b) (Based on the trailing twelve months to September 2023).

Therefore, Guangxi Liugong Machinery has an ROCE of 5.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.0%.

See our latest analysis for Guangxi Liugong Machinery

In the above chart we have measured Guangxi Liugong Machinery'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 Guangxi Liugong Machinery for free.

The Trend Of ROCE

When we looked at the ROCE trend at Guangxi Liugong Machinery, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.8% from 7.9% five years ago. However it looks like Guangxi Liugong Machinery 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'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.

Another thing to note, Guangxi Liugong Machinery has a high ratio of current liabilities to total assets of 48%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Guangxi Liugong Machinery's ROCE

Bringing it all together, while we're somewhat encouraged by Guangxi Liugong Machinery's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 9.0% 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.

If you'd like to know about the risks facing Guangxi Liugong Machinery, we've discovered 2 warning signs that you should be aware of.

While Guangxi Liugong Machinery 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.