Guangzhou Metro Design & Research Institute (SZSE:003013) Could Be Struggling To Allocate Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Guangzhou Metro Design & Research Institute (SZSE:003013), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Guangzhou Metro Design & Research Institute, this is the formula:

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

0.19 = CN¥495m ÷ (CN¥5.4b - CN¥2.7b) (Based on the trailing twelve months to March 2024).

Thus, Guangzhou Metro Design & Research Institute has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 6.5% it's much better.

See our latest analysis for Guangzhou Metro Design & Research Institute

Above you can see how the current ROCE for Guangzhou Metro Design & Research Institute compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Guangzhou Metro Design & Research Institute for free.

The Trend Of ROCE

In terms of Guangzhou Metro Design & Research Institute's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 24%, but since then they've fallen to 19%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.

On a side note, Guangzhou Metro Design & Research Institute has done well to pay down its current liabilities to 51% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Guangzhou Metro Design & Research Institute's ROCE

In summary, Guangzhou Metro Design & Research Institute is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 15% over the last three years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing: We've identified 3 warning signs with Guangzhou Metro Design & Research Institute (at least 1 which can't be ignored) , and understanding them would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.

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