Some Investors May Be Worried About Shandong Longhua New Material's (SZSE:301149) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Shandong Longhua New Material (SZSE:301149) 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. The formula for this calculation on Shandong Longhua New Material is:

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

0.11 = CN¥232m ÷ (CN¥2.5b - CN¥436m) (Based on the trailing twelve months to September 2023).

So, Shandong Longhua New Material has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 5.7% generated by the Chemicals industry.

View our latest analysis for Shandong Longhua New Material

Above you can see how the current ROCE for Shandong Longhua New Material compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Shandong Longhua New Material .

How Are Returns Trending?

When we looked at the ROCE trend at Shandong Longhua New Material, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last five years. 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, Shandong Longhua New Material has decreased its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

While returns have fallen for Shandong Longhua New Material in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, total returns to shareholders over the last year have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a final note, we found 2 warning signs for Shandong Longhua New Material (1 makes us a bit uncomfortable) you should be aware of.

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.