Returns On Capital At Anhui Huaertai Chemical (SZSE:001217) Paint A Concerning Picture

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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 Anhui Huaertai Chemical (SZSE:001217) and its ROCE trend, we weren't exactly thrilled.

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 Anhui Huaertai Chemical is:

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

0.055 = CN¥122m ÷ (CN¥3.0b - CN¥818m) (Based on the trailing twelve months to September 2023).

Therefore, Anhui Huaertai Chemical has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Chemicals industry average of 5.5%.

View our latest analysis for Anhui Huaertai Chemical

Historical performance is a great place to start when researching a stock so above you can see the gauge for Anhui Huaertai Chemical's ROCE against it's prior returns. If you'd like to look at how Anhui Huaertai Chemical has performed in the past in other metrics, you can view this free graph of Anhui Huaertai Chemical's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Anhui Huaertai Chemical doesn't inspire confidence. To be more specific, ROCE has fallen from 23% over the last five years. 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 related note, Anhui Huaertai Chemical has decreased its current liabilities to 27% 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.

What We Can Learn From Anhui Huaertai Chemical's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Anhui Huaertai Chemical have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last year have experienced a 15% depreciation in their investment, so it appears the market might not like these trends either. 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 Anhui Huaertai Chemical (at least 1 which is significant) , and understanding these would certainly be useful.

While Anhui Huaertai Chemical isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com