Jiangnan Group (HKG:1366) Could Be Struggling To Allocate Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. In light of that, when we looked at Jiangnan Group (HKG:1366) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Jiangnan Group, this is the formula:

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

0.086 = CN¥592m ÷ (CN¥17b - CN¥9.7b) (Based on the trailing twelve months to June 2021).

Therefore, Jiangnan Group has an ROCE of 8.6%. Even though it's in line with the industry average of 9.4%, it's still a low return by itself.

Check out our latest analysis for Jiangnan Group

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 Jiangnan Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Jiangnan Group's ROCE Trend?

When we looked at the ROCE trend at Jiangnan Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.6% from 19% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that Jiangnan Group has a current liabilities to total assets ratio of 59%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Jiangnan Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Jiangnan Group is reinvesting for growth and has higher sales as a result. But since the stock has dived 76% in the last five years, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

Jiangnan Group does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are a bit unpleasant...

While Jiangnan Group 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.