Dongguang Chemical (HKG:1702) Hasn't Managed To Accelerate Its Returns

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So, when we ran our eye over Dongguang Chemical's (HKG:1702) trend of ROCE, we liked what we saw.

Understanding 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. Analysts use this formula to calculate it for Dongguang Chemical:

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

0.20 = CN¥290m ÷ (CN¥2.1b - CN¥634m) (Based on the trailing twelve months to June 2021).

Therefore, Dongguang Chemical has an ROCE of 20%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 12% it's much better.

See our latest analysis for Dongguang Chemical

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 Dongguang Chemical 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 Dongguang Chemical Tell Us?

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 20% for the last five years, and the capital employed within the business has risen 36% in that time. 20% is a pretty standard return, and it provides some comfort knowing that Dongguang Chemical has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 30% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.

In Conclusion...

The main thing to remember is that Dongguang Chemical has proven its ability to continually reinvest at respectable rates of return. And given the stock has only risen 1.9% over the last three years, we'd suspect the market is beginning to recognize these trends. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.

On a separate note, we've found 1 warning sign for Dongguang Chemical you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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

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.