Longkou Union Chemical's (SZSE:301209) Returns On Capital Not Reflecting Well On The Business

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Although, when we looked at Longkou Union Chemical (SZSE:301209), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Longkou Union Chemical:

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

0.025 = CN¥17m ÷ (CN¥780m - CN¥100m) (Based on the trailing twelve months to September 2023).

Thus, Longkou Union Chemical has an ROCE of 2.5%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.8%.

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?

When we looked at the ROCE trend at Longkou Union Chemical, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 2.5% from 20% four years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Longkou Union Chemical has done well to pay down its current liabilities to 13% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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

We're a bit apprehensive about Longkou Union 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 21% 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.

Longkou Union Chemical does have some risks, we noticed 3 warning signs (and 1 which is concerning) 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.