Investors Could Be Concerned With Haohua Chemical Science & Technology's (SHSE:600378) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. In light of that, when we looked at Haohua Chemical Science & Technology (SHSE:600378) and its ROCE trend, we weren't exactly thrilled.

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 Haohua Chemical Science & Technology is:

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

0.045 = CN¥747m ÷ (CN¥26b - CN¥9.5b) (Based on the trailing twelve months to September 2024).

Therefore, Haohua Chemical Science & Technology has an ROCE of 4.5%. Even though it's in line with the industry average of 5.5%, it's still a low return by itself.

See our latest analysis for Haohua Chemical Science & Technology

Above you can see how the current ROCE for Haohua Chemical Science & Technology 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 Haohua Chemical Science & Technology for free.

What Can We Tell From Haohua Chemical Science & Technology's ROCE Trend?

On the surface, the trend of ROCE at Haohua Chemical Science & Technology doesn't inspire confidence. Around five years ago the returns on capital were 6.9%, but since then they've fallen to 4.5%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Haohua Chemical Science & Technology's current liabilities have increased over the last five years to 36% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 4.5%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Haohua Chemical Science & Technology's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Haohua Chemical Science & Technology have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 65% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Like most companies, Haohua Chemical Science & Technology does come with some risks, and we've found 2 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.