Capital Allocation Trends At Hangzhou Guotai Environmental Protection TechnologyLtd (SZSE:301203) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. 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 briefly looking over the numbers, we don't think Hangzhou Guotai Environmental Protection TechnologyLtd (SZSE:301203) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Hangzhou Guotai Environmental Protection TechnologyLtd is:

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

0.089 = CN¥125m ÷ (CN¥1.5b - CN¥53m) (Based on the trailing twelve months to June 2024).

Thus, Hangzhou Guotai Environmental Protection TechnologyLtd has an ROCE of 8.9%. On its own that's a low return, but compared to the average of 5.6% generated by the Commercial Services industry, it's much better.

See our latest analysis for Hangzhou Guotai Environmental Protection TechnologyLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hangzhou Guotai Environmental Protection TechnologyLtd's ROCE against it's prior returns. If you'd like to look at how Hangzhou Guotai Environmental Protection TechnologyLtd has performed in the past in other metrics, you can view this free graph of Hangzhou Guotai Environmental Protection TechnologyLtd's past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Hangzhou Guotai Environmental Protection TechnologyLtd, we didn't gain much confidence. Around five years ago the returns on capital were 37%, but since then they've fallen to 8.9%. 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Hangzhou Guotai Environmental Protection TechnologyLtd has done well to pay down its current liabilities to 3.7% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Hangzhou Guotai Environmental Protection TechnologyLtd's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 39% in the last year. 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.

If you'd like to know about the risks facing Hangzhou Guotai Environmental Protection TechnologyLtd, we've discovered 2 warning signs that you should be aware of.

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.