China Golden Classic Group (HKG:8281) May Have Issues Allocating Its Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating China Golden Classic Group (HKG:8281), we don't think it's current trends fit the mold of a multi-bagger.

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 China Golden Classic Group is:

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

0.08 = CN¥19m ÷ (CN¥359m - CN¥122m) (Based on the trailing twelve months to December 2020).

Therefore, China Golden Classic Group has an ROCE of 8.0%. On its own, that's a low figure but it's around the 10.0% average generated by the Personal Products industry.

Check out our latest analysis for China Golden Classic Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Golden Classic Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of China Golden Classic Group, check out these free graphs here.

The Trend Of ROCE

On the surface, the trend of ROCE at China Golden Classic Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 8.0% from 31% five years ago. However it looks like China Golden Classic Group 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.

On a side note, China Golden Classic Group has done well to pay down its current liabilities to 34% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by China Golden Classic Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 49% over the last three years, 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for China Golden Classic Group (of which 1 doesn't sit too well with us!) that you should know about.

While China Golden Classic Group 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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