Capital Allocation Trends At China Sunshine Paper Holdings (HKG:2002) Aren't Ideal

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at China Sunshine Paper Holdings (HKG:2002) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for China Sunshine Paper Holdings, this is the formula:

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

0.052 = CN¥309m ÷ (CN¥12b - CN¥5.9b) (Based on the trailing twelve months to June 2023).

Thus, China Sunshine Paper Holdings has an ROCE of 5.2%. In absolute terms, that's a low return and it also under-performs the Packaging industry average of 6.5%.

Check out our latest analysis for China Sunshine Paper Holdings

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 want to delve into the historical earnings, revenue and cash flow of China Sunshine Paper Holdings, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

In terms of China Sunshine Paper Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 21% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 related note, China Sunshine Paper Holdings has decreased its current liabilities to 50% 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. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On China Sunshine Paper Holdings' ROCE

To conclude, we've found that China Sunshine Paper Holdings is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 132% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you'd like to know more about China Sunshine Paper Holdings, we've spotted 5 warning signs, and 2 of them are concerning.

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.

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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.