Here's What's Concerning About Shanghai Baolijia Chemical's (SZSE:301037) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Shanghai Baolijia Chemical (SZSE:301037), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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. To calculate this metric for Shanghai Baolijia Chemical, this is the formula:

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

0.018 = CN¥17m ÷ (CN¥2.4b - CN¥1.4b) (Based on the trailing twelve months to June 2023).

Therefore, Shanghai Baolijia Chemical has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.0%.

Check out our latest analysis for Shanghai Baolijia Chemical

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 Shanghai Baolijia Chemical has performed in the past in other metrics, you can view this free graph of Shanghai Baolijia Chemical's past earnings, revenue and cash flow.

What Does the ROCE Trend For Shanghai Baolijia Chemical Tell Us?

When we looked at the ROCE trend at Shanghai Baolijia Chemical, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.8% from 22% 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.

Another thing to note, Shanghai Baolijia Chemical has a high ratio of current liabilities to total assets of 60%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Shanghai Baolijia Chemical's ROCE

We're a bit apprehensive about Shanghai Baolijia Chemical 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 26% over the last year, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Shanghai Baolijia Chemical does have some risks, we noticed 4 warning signs (and 3 which shouldn't be ignored) we think you should know about.

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.

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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.