Sunlour PigmentLtd (SZSE:301036) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. However, after investigating Sunlour PigmentLtd (SZSE:301036), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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 Sunlour PigmentLtd, this is the formula:

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

0.012 = CN¥18m ÷ (CN¥1.9b - CN¥301m) (Based on the trailing twelve months to September 2023).

Thus, Sunlour PigmentLtd has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.7%.

See our latest analysis for Sunlour PigmentLtd

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Sunlour PigmentLtd.

The Trend Of ROCE

In terms of Sunlour PigmentLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 9.7%, but since then they've fallen to 1.2%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Sunlour PigmentLtd has decreased its current liabilities to 16% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From Sunlour PigmentLtd's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sunlour PigmentLtd. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing: We've identified 4 warning signs with Sunlour PigmentLtd (at least 1 which is significant) , and understanding these would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.