Shandong Ruifeng Chemical (SZSE:300243) May Have Issues Allocating Its Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Shandong Ruifeng Chemical (SZSE:300243), it didn't seem to tick all of these boxes.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shandong Ruifeng Chemical, this is the formula:

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

0.052 = CN¥88m ÷ (CN¥2.2b - CN¥509m) (Based on the trailing twelve months to March 2024).

Therefore, Shandong Ruifeng Chemical has an ROCE of 5.2%. In absolute terms, that's a low return but it's around the Chemicals industry average of 5.5%.

View our latest analysis for Shandong Ruifeng Chemical

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

How Are Returns Trending?

We weren't thrilled with the trend because Shandong Ruifeng Chemical's ROCE has reduced by 71% over the last five years, while the business employed 163% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Shandong Ruifeng Chemical might not have received a full period of earnings contribution from it.

On a related note, Shandong Ruifeng Chemical has decreased its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Shandong Ruifeng Chemical's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 52% 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.

Shandong Ruifeng Chemical does have some risks, we noticed 5 warning signs (and 3 which are concerning) we think you should know about.

While Shandong Ruifeng Chemical 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.