Here's What's Concerning About LB Group's (SZSE:002601) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 LB Group (SZSE:002601) 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 who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for LB Group:

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

0.12 = CN¥4.6b ÷ (CN¥66b - CN¥27b) (Based on the trailing twelve months to March 2024).

Therefore, LB Group has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.5% it's much better.

Check out our latest analysis for LB Group

Above you can see how the current ROCE for LB Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering LB Group for free.

How Are Returns Trending?

When we looked at the ROCE trend at LB Group, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 12%. However it looks like LB Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, LB Group's current liabilities are still rather high at 41% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

To conclude, we've found that LB Group is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 69% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing: We've identified 2 warning signs with LB Group (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

While LB 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.