Cangzhou Dahua's (SHSE:600230) Returns On Capital Not Reflecting Well On The Business

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. However, after briefly looking over the numbers, we don't think Cangzhou Dahua (SHSE:600230) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Cangzhou Dahua is:

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

0.087 = CN¥482m ÷ (CN¥6.9b - CN¥1.4b) (Based on the trailing twelve months to September 2023).

Thus, Cangzhou Dahua has an ROCE of 8.7%. In absolute terms, that's a low return, but it's much better than the Chemicals industry average of 5.9%.

View our latest analysis for Cangzhou Dahua

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cangzhou Dahua's ROCE against it's prior returns. If you'd like to look at how Cangzhou Dahua has performed in the past in other metrics, you can view this free graph of Cangzhou Dahua's past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Cangzhou Dahua, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.7% from 50% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Cangzhou Dahua's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 52% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Cangzhou Dahua has the makings of a multi-bagger.

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

While Cangzhou Dahua 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.