Shanxi Lu'an Environmental Energy Development (SHSE:601699) Could Be Struggling To Allocate Capital

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. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Shanxi Lu'an Environmental Energy Development (SHSE:601699), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shanxi Lu'an Environmental Energy Development, this is the formula:

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

0.10 = CN¥5.9b ÷ (CN¥93b - CN¥36b) (Based on the trailing twelve months to September 2024).

Therefore, Shanxi Lu'an Environmental Energy Development has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 10.0%.

Check out our latest analysis for Shanxi Lu'an Environmental Energy Development

In the above chart we have measured Shanxi Lu'an Environmental Energy Development's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanxi Lu'an Environmental Energy Development for free.

What Can We Tell From Shanxi Lu'an Environmental Energy Development's ROCE Trend?

When we looked at the ROCE trend at Shanxi Lu'an Environmental Energy Development, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Shanxi Lu'an Environmental Energy Development has decreased its current liabilities to 39% 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.

Our Take On Shanxi Lu'an Environmental Energy Development's ROCE

In summary, we're somewhat concerned by Shanxi Lu'an Environmental Energy Development's diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 199%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you want to know some of the risks facing Shanxi Lu'an Environmental Energy Development we've found 2 warning signs (1 is concerning!) that you should be aware of before investing here.

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.