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

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Huarong Chemical (SZSE:301256), it didn't seem to tick all of these boxes.

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

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. To calculate this metric for Huarong Chemical, this is the formula:

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

0.039 = CN¥66m ÷ (CN¥2.7b - CN¥987m) (Based on the trailing twelve months to September 2024).

Therefore, Huarong Chemical has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.4%.

Check out our latest analysis for Huarong Chemical

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. 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 Can We Tell From Huarong Chemical's ROCE Trend?

When we looked at the ROCE trend at Huarong Chemical, we didn't gain much confidence. To be more specific, ROCE has fallen from 23% over the last five years. 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 may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

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. Although the market must be expecting these trends to improve because the stock has gained 13% over the last year. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Huarong Chemical does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those make us uncomfortable...

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.