Capital Allocation Trends At Longxing Chemical Stock (SZSE:002442) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Longxing Chemical Stock (SZSE:002442), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Longxing Chemical Stock, this is the formula:

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

0.069 = CN¥221m ÷ (CN¥4.7b - CN¥1.5b) (Based on the trailing twelve months to March 2024).

Therefore, Longxing Chemical Stock has an ROCE of 6.9%. On its own that's a low return, but compared to the average of 5.7% generated by the Chemicals industry, it's much better.

Check out our latest analysis for Longxing Chemical Stock

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

The Trend Of ROCE

When we looked at the ROCE trend at Longxing Chemical Stock, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.9% from 12% five years ago. 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 related note, Longxing Chemical Stock has decreased its current liabilities to 32% of total assets. So we could link some of this to the decrease in ROCE. 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 Key Takeaway

We're a bit apprehensive about Longxing Chemical Stock because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last five years have experienced a 23% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Like most companies, Longxing Chemical Stock does come with some risks, and we've found 1 warning sign that you should be aware of.

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.