Capital Allocation Trends At Malion New Materials (SZSE:300586) Aren't Ideal

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Malion New Materials (SZSE:300586) 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. Analysts use this formula to calculate it for Malion New Materials:

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

0.028 = CN¥82m ÷ (CN¥3.5b - CN¥587m) (Based on the trailing twelve months to September 2024).

Thus, Malion New Materials has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.

Check out our latest analysis for Malion New Materials

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 Malion New Materials has performed in the past in other metrics, you can view this free graph of Malion New Materials' past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Malion New Materials, we didn't gain much confidence. Around five years ago the returns on capital were 8.4%, but since then they've fallen to 2.8%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Malion New Materials has decreased its current liabilities to 17% 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.

Our Take On Malion New Materials' ROCE

In summary, we're somewhat concerned by Malion New Materials' diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 12% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Malion New Materials does have some risks though, and we've spotted 3 warning signs for Malion New Materials that you might be interested in.

While Malion 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.

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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.