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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Liuzhou Chemical Industry (SHSE:600423) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on Liuzhou Chemical Industry is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = CN¥6.1m ÷ (CN¥531m - CN¥70m) (Based on the trailing twelve months to September 2023).
Therefore, Liuzhou Chemical Industry has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.7%.
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'd like to look at how Liuzhou Chemical Industry has performed in the past in other metrics, you can view this free graph of Liuzhou Chemical Industry's past earnings, revenue and cash flow.
The Trend Of ROCE
We're delighted to see that Liuzhou Chemical Industry is reaping rewards from its investments and has now broken into profitability. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 1.3% on their capital employed. Additionally, the business is utilizing 23% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.
One more thing to note, Liuzhou Chemical Industry has decreased current liabilities to 13% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
What We Can Learn From Liuzhou Chemical Industry's ROCE
From what we've seen above, Liuzhou Chemical Industry has managed to increase it's returns on capital all the while reducing it's capital base. And since the stock has fallen 29% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.
On a separate note, we've found 2 warning signs for Liuzhou Chemical Industry you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.