Zhejiang Huakang Pharmaceutical (SHSE:605077) May Have Issues Allocating Its Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Having said that, from a first glance at Zhejiang Huakang Pharmaceutical (SHSE:605077) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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 Zhejiang Huakang Pharmaceutical:

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

0.072 = CN¥391m ÷ (CN¥6.3b - CN¥855m) (Based on the trailing twelve months to March 2024).

Therefore, Zhejiang Huakang Pharmaceutical has an ROCE of 7.2%. In absolute terms, that's a low return but it's around the Food industry average of 7.7%.

See our latest analysis for Zhejiang Huakang Pharmaceutical

Above you can see how the current ROCE for Zhejiang Huakang Pharmaceutical 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 Zhejiang Huakang Pharmaceutical for free.

How Are Returns Trending?

In terms of Zhejiang Huakang Pharmaceutical's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.2% from 38% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Zhejiang Huakang Pharmaceutical has done well to pay down its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Bottom Line On Zhejiang Huakang Pharmaceutical's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Zhejiang Huakang Pharmaceutical is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 36% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Zhejiang Huakang Pharmaceutical (of which 1 is significant!) that you should know about.

While Zhejiang Huakang Pharmaceutical isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.