Wells Advanced Materials (Shanghai) (SZSE:301555) Could Be Struggling To Allocate 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. 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 Wells Advanced Materials (Shanghai) (SZSE:301555), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Wells Advanced Materials (Shanghai) is:

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

0.0064 = CN¥7.4m ÷ (CN¥2.1b - CN¥947m) (Based on the trailing twelve months to September 2024).

Therefore, Wells Advanced Materials (Shanghai) has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

Check out our latest analysis for Wells Advanced Materials (Shanghai)

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 Wells Advanced Materials (Shanghai) has performed in the past in other metrics, you can view this free graph of Wells Advanced Materials (Shanghai)'s past earnings, revenue and cash flow.

So How Is Wells Advanced Materials (Shanghai)'s ROCE Trending?

When we looked at the ROCE trend at Wells Advanced Materials (Shanghai), we didn't gain much confidence. To be more specific, ROCE has fallen from 5.4% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.

Another thing to note, Wells Advanced Materials (Shanghai) has a high ratio of current liabilities to total assets of 45%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

In summary, Wells Advanced Materials (Shanghai) is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 37% over the last year, investors may not be too optimistic on this trend improving either. 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.

If you'd like to know more about Wells Advanced Materials (Shanghai), we've spotted 3 warning signs, and 2 of them are concerning.

While Wells Advanced Materials (Shanghai) may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.