Longkou Union Chemical (SZSE:301209) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Longkou Union Chemical (SZSE:301209) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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 Longkou Union Chemical, this is the formula:

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

0.042 = CN¥30m ÷ (CN¥829m - CN¥122m) (Based on the trailing twelve months to March 2024).

So, Longkou Union Chemical has an ROCE of 4.2%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.

Check out our latest analysis for Longkou Union Chemical

Historical performance is a great place to start when researching a stock so above you can see the gauge for Longkou Union Chemical's ROCE against it's prior returns. If you're interested in investigating Longkou Union Chemical's past further, check out this free graph covering Longkou Union Chemical's past earnings, revenue and cash flow.

So How Is Longkou Union Chemical's ROCE Trending?

In terms of Longkou Union Chemical's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 18% over the last five years. However it looks like Longkou Union Chemical might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Longkou Union Chemical has decreased its current liabilities to 15% 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 Longkou Union Chemical's ROCE

To conclude, we've found that Longkou Union Chemical is reinvesting in the business, but returns have been falling. Unsurprisingly then, the total return to shareholders over the last year has been flat. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing to note, we've identified 2 warning signs with Longkou Union Chemical and understanding these should be part of your investment process.

While Longkou Union Chemical isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.

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