Returns On Capital At Dongguang Chemical (HKG:1702) Paint A Concerning Picture

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Dongguang Chemical (HKG:1702) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.15 = CN¥277m ÷ (CN¥2.0b - CN¥183m) (Based on the trailing twelve months to June 2024).

So, Dongguang Chemical has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 6.0% 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 Dongguang Chemical's past earnings, revenue and cash flow.

What Does the ROCE Trend For Dongguang Chemical Tell Us?

When we looked at the ROCE trend at Dongguang Chemical, we didn't gain much confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 15%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Dongguang Chemical has done well to pay down its current liabilities to 9.0% 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. 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

From the above analysis, we find it rather worrisome that returns on capital and sales for Dongguang Chemical have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 18% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching Dongguang Chemical, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Dongguang Chemical 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.

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.