Guangdong Redwall New Materials (SZSE:002809) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Guangdong Redwall New Materials (SZSE:002809), we don't think it's current trends fit the mold of a multi-bagger.

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 Guangdong Redwall New Materials is:

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

0.038 = CN¥86m ÷ (CN¥2.5b - CN¥217m) (Based on the trailing twelve months to March 2024).

Thus, Guangdong Redwall New Materials has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

Check out our latest analysis for Guangdong Redwall New Materials

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Guangdong Redwall New Materials, we didn't gain much confidence. Around five years ago the returns on capital were 7.0%, but since then they've fallen to 3.8%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Guangdong Redwall New Materials has done well to pay down its current liabilities to 8.8% 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.

In Conclusion...

In summary, we're somewhat concerned by Guangdong Redwall New Materials' diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 22% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Guangdong Redwall New Materials does have some risks, we noticed 2 warning signs (and 1 which is significant) we think you should know about.

While Guangdong Redwall New Materials 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com