Capital Allocation Trends At China Risun Group (HKG:1907) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Having said that, from a first glance at China Risun Group (HKG:1907) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

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 China Risun Group is:

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

0.038 = CN¥950m ÷ (CN¥53b - CN¥28b) (Based on the trailing twelve months to June 2023).

Therefore, China Risun Group has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 9.3%.

View our latest analysis for China Risun Group

Above you can see how the current ROCE for China Risun Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Risun Group.

The Trend Of ROCE

In terms of China Risun Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.8% from 29% five years ago. However it looks like China Risun 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 Risun Group has done well to pay down its current liabilities to 52% 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. Keep in mind 52% is still pretty high, so those risks are still somewhat prevalent.

Our Take On China Risun Group's ROCE

In summary, China Risun Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 49% over the last three years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

China Risun Group does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.