Hualan Group (SZSE:301027) Might Be Having Difficulty Using Its Capital Effectively

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. However, after investigating Hualan Group (SZSE:301027), we don't think it's current trends fit the mold of a multi-bagger.

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

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 Hualan Group, this is the formula:

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

0.017 = CN¥19m ÷ (CN¥2.0b - CN¥836m) (Based on the trailing twelve months to June 2024).

Thus, Hualan Group has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.4%.

View our latest analysis for Hualan Group

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

What The Trend Of ROCE Can Tell Us

In terms of Hualan Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 31%, but since then they've fallen to 1.7%. 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 side note, Hualan Group has done well to pay down its current liabilities to 42% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Hualan Group have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 51% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Hualan Group does have some risks though, and we've spotted 3 warning signs for Hualan Group that you might be interested in.

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.