Wuhan Tianyuan Environmental ProtectionLTD (SZSE:301127) Could Be Struggling To Allocate Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Wuhan Tianyuan Environmental ProtectionLTD (SZSE:301127), it didn't seem to tick all of these boxes.

Understanding 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 Wuhan Tianyuan Environmental ProtectionLTD, this is the formula:

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

0.08 = CN¥405m ÷ (CN¥6.3b - CN¥1.3b) (Based on the trailing twelve months to September 2024).

Therefore, Wuhan Tianyuan Environmental ProtectionLTD has an ROCE of 8.0%. In absolute terms, that's a low return, but it's much better than the Commercial Services industry average of 5.3%.

View our latest analysis for Wuhan Tianyuan Environmental ProtectionLTD

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Wuhan Tianyuan Environmental ProtectionLTD, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.0% from 17% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Wuhan Tianyuan Environmental ProtectionLTD has done well to pay down its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. 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 On Wuhan Tianyuan Environmental ProtectionLTD's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Wuhan Tianyuan Environmental ProtectionLTD is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 26% over the last three years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you want to know some of the risks facing Wuhan Tianyuan Environmental ProtectionLTD we've found 4 warning signs (2 are a bit concerning!) that you should be aware of before investing here.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.