Capital Allocation Trends At Lier ChemicalLTD (SZSE:002258) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Lier ChemicalLTD (SZSE:002258) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Lier ChemicalLTD is:

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

0.084 = CN¥881m ÷ (CN¥14b - CN¥3.1b) (Based on the trailing twelve months to December 2023).

Thus, Lier ChemicalLTD has an ROCE of 8.4%. In absolute terms, that's a low return, but it's much better than the Chemicals industry average of 5.7%.

View our latest analysis for Lier ChemicalLTD

In the above chart we have measured Lier ChemicalLTD'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 Lier ChemicalLTD for free.

What The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't look fantastic because it's fallen from 21% five years ago, while the business's capital employed increased by 181%. That being said, Lier ChemicalLTD raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Lier ChemicalLTD's earnings and if they change as a result from the capital raise.

On a side note, Lier ChemicalLTD has done well to pay down its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Lier ChemicalLTD's ROCE

In summary, we're somewhat concerned by Lier ChemicalLTD's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 15% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching Lier ChemicalLTD, you might be interested to know about the 2 warning signs that our analysis has discovered.

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.