Capital Allocation Trends At Lihuayi Weiyuan Chemical (SHSE:600955) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 investigating Lihuayi Weiyuan Chemical (SHSE:600955), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Lihuayi Weiyuan Chemical is:

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

0.0085 = CN¥97m ÷ (CN¥14b - CN¥2.1b) (Based on the trailing twelve months to September 2024).

Thus, Lihuayi Weiyuan Chemical has an ROCE of 0.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

See our latest analysis for Lihuayi Weiyuan Chemical

Historical performance is a great place to start when researching a stock so above you can see the gauge for Lihuayi Weiyuan Chemical's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Lihuayi Weiyuan Chemical.

So How Is Lihuayi Weiyuan Chemical's ROCE Trending?

When we looked at the ROCE trend at Lihuayi Weiyuan Chemical, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 0.9% from 26% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Lihuayi Weiyuan Chemical has done well to pay down its current liabilities to 16% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Lihuayi Weiyuan Chemical's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Lihuayi Weiyuan Chemical. However, despite the promising trends, the stock has fallen 65% over the last three years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Lihuayi Weiyuan Chemical (of which 1 doesn't sit too well with us!) that you should know about.

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.