If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Hailir Pesticides and Chemicals GroupLtd (SHSE:603639), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Hailir Pesticides and Chemicals GroupLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = CN¥508m ÷ (CN¥6.4b - CN¥2.7b) (Based on the trailing twelve months to September 2023).
Thus, Hailir Pesticides and Chemicals GroupLtd has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 5.7% generated by the Chemicals industry.
In the above chart we have measured Hailir Pesticides and Chemicals GroupLtd'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 Hailir Pesticides and Chemicals GroupLtd.
How Are Returns Trending?
In terms of Hailir Pesticides and Chemicals GroupLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 22%, but since then they've fallen to 14%. 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, Hailir Pesticides and Chemicals GroupLtd's current liabilities have increased over the last five years to 42% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 14%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
Our Take On Hailir Pesticides and Chemicals GroupLtd's ROCE
In summary, Hailir Pesticides and Chemicals GroupLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 8.7% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
Hailir Pesticides and Chemicals GroupLtd does have some risks though, and we've spotted 1 warning sign for Hailir Pesticides and Chemicals GroupLtd that you might be interested in.
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.