Capital Allocation Trends At Guangdong Construction Engineering Group (SZSE:002060) Aren't Ideal

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Having said that, from a first glance at Guangdong Construction Engineering Group (SZSE:002060) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 Guangdong Construction Engineering Group is:

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

0.032 = CN¥1.1b ÷ (CN¥117b - CN¥82b) (Based on the trailing twelve months to September 2023).

Thus, Guangdong Construction Engineering Group has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.9%.

See our latest analysis for Guangdong Construction Engineering Group

Above you can see how the current ROCE for Guangdong Construction Engineering Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Guangdong Construction Engineering Group .

What Does the ROCE Trend For Guangdong Construction Engineering Group Tell Us?

The trend of ROCE doesn't look fantastic because it's fallen from 6.4% five years ago, while the business's capital employed increased by 262%. Usually this isn't ideal, but given Guangdong Construction Engineering Group conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Guangdong Construction Engineering Group probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 70%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From Guangdong Construction Engineering Group's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Guangdong Construction Engineering Group have fallen, meanwhile the business is employing more capital than it was five years ago. Despite the concerning underlying trends, the stock has actually gained 33% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Guangdong Construction Engineering Group does have some risks, we noticed 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

While Guangdong Construction Engineering 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.