Henan Liliang Diamond's (SZSE:301071) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 briefly looking over the numbers, we don't think Henan Liliang Diamond (SZSE:301071) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Henan Liliang Diamond is:

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

0.039 = CN¥223m ÷ (CN¥6.5b - CN¥825m) (Based on the trailing twelve months to September 2024).

Therefore, Henan Liliang Diamond has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

View our latest analysis for Henan Liliang Diamond

In the above chart we have measured Henan Liliang Diamond's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Henan Liliang Diamond .

What Does the ROCE Trend For Henan Liliang Diamond Tell Us?

On the surface, the trend of ROCE at Henan Liliang Diamond doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 3.9%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Henan Liliang Diamond has decreased its current liabilities to 13% 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.

The Bottom Line On Henan Liliang Diamond's ROCE

In summary, Henan Liliang Diamond is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last three years, the stock has given away 45% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Henan Liliang Diamond does have some risks, we noticed 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

While Henan Liliang Diamond 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.

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.