Here's What To Make Of Hengli PetrochemicalLtd's (SHSE:600346) Decelerating Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So, when we ran our eye over Hengli PetrochemicalLtd's (SHSE:600346) trend of ROCE, we liked what we saw.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Hengli PetrochemicalLtd is:

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

0.10 = CN¥14b ÷ (CN¥274b - CN¥134b) (Based on the trailing twelve months to June 2024).

Therefore, Hengli PetrochemicalLtd has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.5% it's much better.

Check out our latest analysis for Hengli PetrochemicalLtd

Above you can see how the current ROCE for Hengli PetrochemicalLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Hengli PetrochemicalLtd .

What The Trend Of ROCE Can Tell Us

While the current returns on capital are decent, they haven't changed much. The company has employed 78% more capital in the last five years, and the returns on that capital have remained stable at 10%. 10% is a pretty standard return, and it provides some comfort knowing that Hengli PetrochemicalLtd has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

On a side note, Hengli PetrochemicalLtd's current liabilities are still rather high at 49% of total assets. 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.

What We Can Learn From Hengli PetrochemicalLtd's ROCE

In the end, Hengli PetrochemicalLtd has proven its ability to adequately reinvest capital at good rates of return. And given the stock has only risen 17% over the last five years, we'd suspect the market is beginning to recognize these trends. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.

One more thing: We've identified 2 warning signs with Hengli PetrochemicalLtd (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

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.