Dongguang Chemical's (HKG:1702) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Dongguang Chemical (HKG:1702) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Dongguang Chemical is:

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

0.14 = CN¥174m ÷ (CN¥1.8b - CN¥480m) (Based on the trailing twelve months to December 2020).

Thus, Dongguang Chemical has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 9.5% it's much better.

See our latest analysis for Dongguang Chemical

Historical performance is a great place to start when researching a stock so above you can see the gauge for Dongguang Chemical's ROCE against it's prior returns. 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 Can We Tell From Dongguang Chemical's ROCE Trend?

In terms of Dongguang Chemical's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 36%, but since then they've fallen to 14%. However it looks like Dongguang Chemical 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Dongguang Chemical has done well to pay down its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Dongguang Chemical's ROCE

To conclude, we've found that Dongguang Chemical is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 60% in the last three years. Therefore based on the analysis done in this article, we don't think Dongguang Chemical has the makings of a multi-bagger.

One more thing, we've spotted 1 warning sign facing Dongguang Chemical that you might find interesting.

While Dongguang Chemical 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. 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.
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