Chengdu Hongqi ChainLtd's (SZSE:002697) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Chengdu Hongqi ChainLtd (SZSE:002697) 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)

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. The formula for this calculation on Chengdu Hongqi ChainLtd is:

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

0.10 = CN¥479m ÷ (CN¥8.3b - CN¥3.5b) (Based on the trailing twelve months to September 2024).

So, Chengdu Hongqi ChainLtd has an ROCE of 10.0%. In absolute terms, that's a low return, but it's much better than the Consumer Retailing industry average of 6.0%.

View our latest analysis for Chengdu Hongqi ChainLtd

Above you can see how the current ROCE for Chengdu Hongqi ChainLtd 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 Chengdu Hongqi ChainLtd for free.

The Trend Of ROCE

When we looked at the ROCE trend at Chengdu Hongqi ChainLtd, we didn't gain much confidence. To be more specific, ROCE has fallen from 13% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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, Chengdu Hongqi ChainLtd's current liabilities are still rather high at 42% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Chengdu Hongqi ChainLtd's ROCE

To conclude, we've found that Chengdu Hongqi ChainLtd is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 31% in the last five years. 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 Chengdu Hongqi ChainLtd, 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.