Guangdong Sanhe Pile's (SZSE:003037) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Having said that, from a first glance at Guangdong Sanhe Pile (SZSE:003037) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Guangdong Sanhe Pile is:

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

0.024 = CN¥86m ÷ (CN¥6.6b - CN¥3.0b) (Based on the trailing twelve months to June 2024).

So, Guangdong Sanhe Pile has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Basic Materials industry average of 5.9%.

View our latest analysis for Guangdong Sanhe Pile

Historical performance is a great place to start when researching a stock so above you can see the gauge for Guangdong Sanhe Pile's ROCE against it's prior returns. If you're interested in investigating Guangdong Sanhe Pile's past further, check out this free graph covering Guangdong Sanhe Pile's past earnings, revenue and cash flow.

What Can We Tell From Guangdong Sanhe Pile's ROCE Trend?

We weren't thrilled with the trend because Guangdong Sanhe Pile's ROCE has reduced by 90% over the last five years, while the business employed 237% more capital. Usually this isn't ideal, but given Guangdong Sanhe Pile conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Guangdong Sanhe Pile's earnings and if they change as a result from the capital raise.

On a related note, Guangdong Sanhe Pile has decreased its current liabilities to 46% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Guangdong Sanhe Pile's ROCE

We're a bit apprehensive about Guangdong Sanhe Pile because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 50% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Guangdong Sanhe Pile does come with some risks though, we found 4 warning signs in our investment analysis, and 3 of those are a bit unpleasant...

While Guangdong Sanhe Pile isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.