Capital Allocation Trends At Sichuan Hezong Medicine Easy-to-buy Pharmaceutical (SZSE:300937) Aren't Ideal

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Sichuan Hezong Medicine Easy-to-buy Pharmaceutical (SZSE:300937) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Sichuan Hezong Medicine Easy-to-buy Pharmaceutical:

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

0.035 = CN¥30m ÷ (CN¥1.7b - CN¥807m) (Based on the trailing twelve months to June 2024).

So, Sichuan Hezong Medicine Easy-to-buy Pharmaceutical has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the Consumer Retailing industry average of 6.1%.

See our latest analysis for Sichuan Hezong Medicine Easy-to-buy Pharmaceutical

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sichuan Hezong Medicine Easy-to-buy Pharmaceutical doesn't inspire confidence. To be more specific, ROCE has fallen from 16% over the last five years. However it looks like Sichuan Hezong Medicine Easy-to-buy Pharmaceutical might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 48%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.5%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Sichuan Hezong Medicine Easy-to-buy Pharmaceutical's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 49% over the last three years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Sichuan Hezong Medicine Easy-to-buy Pharmaceutical has the makings of a multi-bagger.

If you'd like to know more about Sichuan Hezong Medicine Easy-to-buy Pharmaceutical, we've spotted 4 warning signs, and 1 of them can't be ignored.

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.