Shenglong Splendecor International (HKG:8481) Is Reinvesting At Lower Rates Of Return

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Although, when we looked at Shenglong Splendecor International (HKG:8481), it didn't seem to tick all of these boxes.

What is 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. The formula for this calculation on Shenglong Splendecor International is:

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

0.11 = CN¥30m ÷ (CN¥544m - CN¥267m) (Based on the trailing twelve months to June 2021).

Thus, Shenglong Splendecor International has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 9.1% generated by the Commercial Services industry.

View our latest analysis for Shenglong Splendecor International

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

What Does the ROCE Trend For Shenglong Splendecor International Tell Us?

On the surface, the trend of ROCE at Shenglong Splendecor International doesn't inspire confidence. Over the last five years, returns on capital have decreased to 11% from 15% 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 Shenglong Splendecor International has a current liabilities to total assets ratio of 49%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Shenglong Splendecor International's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Shenglong Splendecor International. And there could be an opportunity here if other metrics look good too, because the stock has declined 39% in the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified 3 warning signs with Shenglong Splendecor International (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

While Shenglong Splendecor International 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.

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.

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