There Are Reasons To Feel Uneasy About Jianzhong Construction Development's (HKG:589) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Jianzhong Construction Development (HKG:589), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Jianzhong Construction Development is:

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

0.067 = CN¥81m ÷ (CN¥2.3b - CN¥1.1b) (Based on the trailing twelve months to December 2020).

Therefore, Jianzhong Construction Development has an ROCE of 6.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.4%.

View our latest analysis for Jianzhong Construction Development

Historical performance is a great place to start when researching a stock so above you can see the gauge for Jianzhong Construction Development's ROCE against it's prior returns. If you're interested in investigating Jianzhong Construction Development's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Jianzhong Construction Development, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 6.7% from 34% four years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 related note, Jianzhong Construction Development has decreased its current liabilities to 47% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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. Keep in mind 47% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Jianzhong Construction Development's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Jianzhong Construction Development have fallen, meanwhile the business is employing more capital than it was four years ago. Long term shareholders who've owned the stock over the last year have experienced a 40% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Jianzhong Construction Development does have some risks, we noticed 5 warning signs (and 1 which is a bit unpleasant) we think you should know about.

While Jianzhong Construction Development 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.

When trading stocks or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.