Returns On Capital At Chung Hwa Chemical Industrial Works (TWSE:1727) Paint A Concerning Picture

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Having said that, from a first glance at Chung Hwa Chemical Industrial Works (TWSE:1727) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Chung Hwa Chemical Industrial Works:

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

0.0071 = NT$15m ÷ (NT$2.9b - NT$752m) (Based on the trailing twelve months to June 2024).

So, Chung Hwa Chemical Industrial Works has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.6%.

View our latest analysis for Chung Hwa Chemical Industrial Works

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chung Hwa Chemical Industrial Works' ROCE against it's prior returns. If you'd like to look at how Chung Hwa Chemical Industrial Works has performed in the past in other metrics, you can view this free graph of Chung Hwa Chemical Industrial Works' past earnings, revenue and cash flow.

What Does the ROCE Trend For Chung Hwa Chemical Industrial Works Tell Us?

On the surface, the trend of ROCE at Chung Hwa Chemical Industrial Works doesn't inspire confidence. To be more specific, ROCE has fallen from 3.3% over the last five years. However it looks like Chung Hwa Chemical Industrial Works might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Chung Hwa Chemical Industrial Works has done well to pay down its current liabilities to 26% of total assets. So we could link some of this to the decrease 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.

The Bottom Line

To conclude, we've found that Chung Hwa Chemical Industrial Works is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 235% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing: We've identified 4 warning signs with Chung Hwa Chemical Industrial Works (at least 1 which is a bit concerning) , and understanding these would certainly be useful.

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.