China Sunshine Paper Holdings (HKG:2002) Could Be Struggling To Allocate Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating China Sunshine Paper Holdings (HKG:2002), we don't think it's current trends fit the mold of a multi-bagger.

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 Sunshine Paper Holdings is:

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).

So, 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%.

View our latest analysis for China Sunshine Paper Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Sunshine Paper Holdings' ROCE against it's prior returns. If you're interested in investigating China Sunshine Paper Holdings' past further, check out this free graph covering China Sunshine Paper Holdings' past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at China Sunshine Paper Holdings doesn't inspire confidence. Around five years ago the returns on capital were 21%, but since then they've fallen to 5.2%. 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 side note, China Sunshine Paper Holdings has done well to pay down 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From China Sunshine Paper Holdings' ROCE

Bringing it all together, while we're somewhat encouraged by China Sunshine Paper Holdings' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 29% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

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

While China Sunshine Paper Holdings 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. 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.