China Shanshui Cement Group's (HKG:691) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Having said that, while the ROCE is currently high for China Shanshui Cement Group (HKG:691), we aren't jumping out of our chairs because returns are decreasing.

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. To calculate this metric for China Shanshui Cement Group, this is the formula:

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

0.21 = CN¥4.3b ÷ (CN¥31b - CN¥10b) (Based on the trailing twelve months to June 2022).

Therefore, China Shanshui Cement Group has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Basic Materials industry average of 7.5%.

Check out the opportunities and risks within the HK Basic Materials industry.

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're interested in investigating China Shanshui Cement Group's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of China Shanshui Cement Group's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 26%. 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, China Shanshui Cement Group has done well to pay down its current liabilities to 33% of total assets. Since the ratio used to be 84%, that's a significant reduction and it no doubt explains the drop in ROCE. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by China Shanshui Cement Group's reinvestment in its own business, we're aware that returns are shrinking. And in the last three years, the stock has given away 36% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a separate note, we've found 2 warning signs for China Shanshui Cement Group you'll probably want to know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.