Shandong Fiberglass Group (SHSE:605006) May Have Issues Allocating Its Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. 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 Shandong Fiberglass Group (SHSE:605006), it didn't seem to tick all of these boxes.

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 Shandong Fiberglass Group is:

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

0.0016 = CN¥6.8m ÷ (CN¥5.7b - CN¥1.4b) (Based on the trailing twelve months to September 2023).

Thus, Shandong Fiberglass Group has an ROCE of 0.2%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.9%.

View our latest analysis for Shandong Fiberglass Group

In the above chart we have measured Shandong Fiberglass Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shandong Fiberglass Group for free.

What Can We Tell From Shandong Fiberglass Group's ROCE Trend?

When we looked at the ROCE trend at Shandong Fiberglass Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Shandong Fiberglass Group has done well to pay down its current liabilities to 25% 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.

In Conclusion...

In summary, we're somewhat concerned by Shandong Fiberglass Group's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 54% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 4 warning signs with Shandong Fiberglass Group (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.

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.