Returns On Capital Signal Tricky Times Ahead For Yangzhou Chenhua New Material (SZSE:300610)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Yangzhou Chenhua New Material (SZSE:300610) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Yangzhou Chenhua New Material:

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

0.028 = CN¥34m ÷ (CN¥1.6b - CN¥337m) (Based on the trailing twelve months to March 2024).

So, Yangzhou Chenhua New Material has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

See our latest analysis for Yangzhou Chenhua New Material

Above you can see how the current ROCE for Yangzhou Chenhua New Material compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Yangzhou Chenhua New Material .

How Are Returns Trending?

When we looked at the ROCE trend at Yangzhou Chenhua New Material, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.8% from 11% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Yangzhou Chenhua New Material's current liabilities have increased over the last five years to 22% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.8%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

We're a bit apprehensive about Yangzhou Chenhua New Material because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 4.1% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Yangzhou Chenhua New Material does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.

While Yangzhou Chenhua New Material 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.