The Returns On Capital At Shanxi Huhua Group (SZSE:003002) Don't Inspire Confidence

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. In light of that, when we looked at Shanxi Huhua Group (SZSE:003002) and its ROCE trend, we weren't exactly thrilled.

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

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. The formula for this calculation on Shanxi Huhua Group is:

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

0.087 = CN¥133m ÷ (CN¥2.0b - CN¥502m) (Based on the trailing twelve months to September 2024).

So, Shanxi Huhua Group has an ROCE of 8.7%. In absolute terms, that's a low return, but it's much better than the Chemicals industry average of 5.6%.

View our latest analysis for Shanxi Huhua Group

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Shanxi Huhua Group has performed in the past in other metrics, you can view this free graph of Shanxi Huhua Group's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Shanxi Huhua Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 12% over the last five years. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Shanxi Huhua 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 119% gain to shareholders who have held over the last three years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know about the risks facing Shanxi Huhua Group, we've discovered 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.