Huarong Chemical (SZSE:301256) Might Be Having Difficulty Using Its Capital Effectively

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Huarong Chemical (SZSE:301256), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Huarong Chemical:

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

0.031 = CN¥53m ÷ (CN¥2.5b - CN¥744m) (Based on the trailing twelve months to December 2023).

Thus, Huarong Chemical has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 6.0%.

Check out our latest analysis for Huarong Chemical

Historical performance is a great place to start when researching a stock so above you can see the gauge for Huarong Chemical's ROCE against it's prior returns. If you'd like to look at how Huarong Chemical has performed in the past in other metrics, you can view this free graph of Huarong Chemical's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Huarong Chemical doesn't inspire confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 3.1%. However it looks like Huarong 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, Huarong Chemical has decreased its current liabilities to 30% 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. 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Huarong Chemical's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 29% in the last year. 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 final note, you should learn about the 2 warning signs we've spotted with Huarong Chemical (including 1 which is concerning) .

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.