Anhui Guangxin Agrochemical (SHSE:603599) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at Anhui Guangxin Agrochemical (SHSE:603599), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Anhui Guangxin Agrochemical:

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

0.053 = CN¥511m ÷ (CN¥16b - CN¥5.9b) (Based on the trailing twelve months to September 2024).

Thus, Anhui Guangxin Agrochemical has an ROCE of 5.3%. Even though it's in line with the industry average of 5.5%, it's still a low return by itself.

Check out our latest analysis for Anhui Guangxin Agrochemical

Above you can see how the current ROCE for Anhui Guangxin Agrochemical 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 Anhui Guangxin Agrochemical .

What Can We Tell From Anhui Guangxin Agrochemical's ROCE Trend?

On the surface, the trend of ROCE at Anhui Guangxin Agrochemical doesn't inspire confidence. Around five years ago the returns on capital were 9.5%, but since then they've fallen to 5.3%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Anhui Guangxin Agrochemical's current liabilities have increased over the last five years to 38% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Key Takeaway

In summary, we're somewhat concerned by Anhui Guangxin Agrochemical's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 74% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Anhui Guangxin Agrochemical does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is significant...

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.