Returns On Capital Signal Tricky Times Ahead For Lihuayi Weiyuan Chemical (SHSE:600955)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Lihuayi Weiyuan Chemical (SHSE:600955) 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 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 Lihuayi Weiyuan Chemical is:

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

0.0063 = CN¥72m ÷ (CN¥13b - CN¥2.2b) (Based on the trailing twelve months to June 2024).

So, Lihuayi Weiyuan Chemical has an ROCE of 0.6%. 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

Above you can see how the current ROCE for Lihuayi Weiyuan Chemical compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Lihuayi Weiyuan Chemical .

The Trend Of ROCE

When we looked at the ROCE trend at Lihuayi Weiyuan Chemical, we didn't gain much confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 0.6%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. 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. So we could link some of this to the decrease in ROCE. 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.

Our Take On 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. But since the stock has dived 72% in the last three years, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

One final note, you should learn about the 2 warning signs we've spotted with Lihuayi Weiyuan Chemical (including 1 which shouldn't be ignored) .

While Lihuayi Weiyuan Chemical may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.