Capital Allocation Trends At Sinopec Shanghai Petrochemical (HKG:338) Aren't Ideal

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Sinopec Shanghai Petrochemical (HKG:338) we aren't filled with optimism, but let's investigate further.

Return On Capital Employed (ROCE): What Is It?

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 Sinopec Shanghai Petrochemical, this is the formula:

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

0.031 = CN¥990m ÷ (CN¥54b - CN¥22b) (Based on the trailing twelve months to March 2022).

Thus, Sinopec Shanghai Petrochemical has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 12%.

See our latest analysis for Sinopec Shanghai Petrochemical

In the above chart we have measured Sinopec Shanghai Petrochemical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Sinopec Shanghai Petrochemical.

So How Is Sinopec Shanghai Petrochemical's ROCE Trending?

In terms of Sinopec Shanghai Petrochemical's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 29% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Sinopec Shanghai Petrochemical becoming one if things continue as they have.

On a side note, Sinopec Shanghai Petrochemical's current liabilities have increased over the last five years to 41% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 3.1%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Long term shareholders who've owned the stock over the last five years have experienced a 62% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Sinopec Shanghai Petrochemical (including 1 which is a bit concerning) .

While Sinopec Shanghai Petrochemical 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.