LB Group (SZSE:002601) May Have Issues Allocating Its Capital

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. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at LB Group (SZSE:002601) and its ROCE trend, we weren't exactly thrilled.

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 LB Group is:

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

0.13 = CN¥4.7b ÷ (CN¥67b - CN¥30b) (Based on the trailing twelve months to September 2024).

So, LB Group has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 5.5% generated by the Chemicals industry.

See our latest analysis for LB Group

In the above chart we have measured LB Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for LB Group .

What Can We Tell From LB Group's ROCE Trend?

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 17%, but since then they've fallen to 13%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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 have increased over the last five years to 44% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 13%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From LB Group's ROCE

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 54% 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.

On a final note, we found 2 warning signs for LB Group (1 is a bit unpleasant) you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.