The Returns On Capital At Shanxi Lanhua Sci-Tech VentureLtd (SHSE:600123) Don't Inspire Confidence

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Shanxi Lanhua Sci-Tech VentureLtd (SHSE:600123) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Shanxi Lanhua Sci-Tech VentureLtd, this is the formula:

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

0.074 = CN¥1.6b ÷ (CN¥31b - CN¥9.3b) (Based on the trailing twelve months to September 2024).

So, Shanxi Lanhua Sci-Tech VentureLtd has an ROCE of 7.4%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 10.0%.

Check out our latest analysis for Shanxi Lanhua Sci-Tech VentureLtd

In the above chart we have measured Shanxi Lanhua Sci-Tech VentureLtd's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Shanxi Lanhua Sci-Tech VentureLtd .

What Does the ROCE Trend For Shanxi Lanhua Sci-Tech VentureLtd Tell Us?

In terms of Shanxi Lanhua Sci-Tech VentureLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 9.7%, but since then they've fallen to 7.4%. 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, Shanxi Lanhua Sci-Tech VentureLtd has done well to pay down its current liabilities to 30% of total assets. That could partly explain why the ROCE has dropped. 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. 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.

In Conclusion...

In summary, Shanxi Lanhua Sci-Tech VentureLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 140% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Shanxi Lanhua Sci-Tech VentureLtd does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.