Returns On Capital Signal Tricky Times Ahead For Sichuan SwellfunLtd (SHSE:600779)

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Looking at Sichuan SwellfunLtd (SHSE:600779), it does have a high ROCE right now, but lets see how returns are trending.

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. The formula for this calculation on Sichuan SwellfunLtd is:

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

0.40 = CN¥1.7b ÷ (CN¥8.4b - CN¥4.3b) (Based on the trailing twelve months to June 2024).

Thus, Sichuan SwellfunLtd has an ROCE of 40%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.

See our latest analysis for Sichuan SwellfunLtd

In the above chart we have measured Sichuan SwellfunLtd'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 Sichuan SwellfunLtd for free.

What Can We Tell From Sichuan SwellfunLtd's ROCE Trend?

When we looked at the ROCE trend at Sichuan SwellfunLtd, we didn't gain much confidence. Historically returns on capital were even higher at 50%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that Sichuan SwellfunLtd has a current liabilities to total assets ratio of 51%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sichuan SwellfunLtd. However, despite the promising trends, the stock has fallen 20% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you want to know some of the risks facing Sichuan SwellfunLtd we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.