Anhui Honglu Steel Construction(Group) (SZSE:002541) Could Be Struggling To Allocate Capital

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Anhui Honglu Steel Construction(Group) (SZSE:002541) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Anhui Honglu Steel Construction(Group) is:

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

0.043 = CN¥682m ÷ (CN¥26b - CN¥9.6b) (Based on the trailing twelve months to September 2024).

So, Anhui Honglu Steel Construction(Group) has an ROCE of 4.3%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 6.8%.

Check out our latest analysis for Anhui Honglu Steel Construction(Group)

In the above chart we have measured Anhui Honglu Steel Construction(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 Anhui Honglu Steel Construction(Group) for free.

The Trend Of ROCE

In terms of Anhui Honglu Steel Construction(Group)'s historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 8.3% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Anhui Honglu Steel Construction(Group) has done well to pay down its current liabilities to 38% of total assets. That could partly explain why the ROCE has dropped. 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...

Bringing it all together, while we're somewhat encouraged by Anhui Honglu Steel Construction(Group)'s reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 130% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Anhui Honglu Steel Construction(Group) (of which 1 is a bit unpleasant!) that you should know about.

While Anhui Honglu Steel Construction(Group) may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.