ChenGuang Biotech Group (SZSE:300138) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at ChenGuang Biotech Group (SZSE:300138) 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. The formula for this calculation on ChenGuang Biotech Group is:

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

0.074 = CN¥366m ÷ (CN¥8.4b - CN¥3.5b) (Based on the trailing twelve months to June 2024).

Therefore, ChenGuang Biotech Group has an ROCE of 7.4%. Even though it's in line with the industry average of 7.2%, it's still a low return by itself.

See our latest analysis for ChenGuang Biotech Group

In the above chart we have measured ChenGuang Biotech Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for ChenGuang Biotech Group .

So How Is ChenGuang Biotech Group's ROCE Trending?

When we looked at the ROCE trend at ChenGuang Biotech Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.4% from 11% five years ago. 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.

Another thing to note, ChenGuang Biotech Group has a high ratio of current liabilities to total assets of 41%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On ChenGuang Biotech Group's ROCE

Bringing it all together, while we're somewhat encouraged by ChenGuang Biotech Group's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 29% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

ChenGuang Biotech Group does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

While ChenGuang Biotech Group 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.