Be Wary Of China National Building Material (HKG:3323) And Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. However, after investigating China National Building Material (HKG:3323), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for China National Building Material:

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

0.028 = CN¥9.1b ÷ (CN¥508b - CN¥180b) (Based on the trailing twelve months to September 2023).

Therefore, China National Building Material has an ROCE of 2.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 3.5%.

Check out our latest analysis for China National Building Material

In the above chart we have measured China National Building Material's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China National Building Material for free.

What Can We Tell From China National Building Material's ROCE Trend?

In terms of China National Building Material's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 13%, but since then they've fallen to 2.8%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, China National Building Material has decreased its current liabilities to 35% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 China National Building Material's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for China National Building Material 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 41% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for China National Building Material (of which 2 shouldn't be ignored!) that you should know about.

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.