If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. In light of that, when we looked at Hubei Xingfa Chemicals Group (SHSE:600141) and its ROCE trend, we weren't exactly thrilled.
What Is 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 Hubei Xingfa Chemicals Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = CN¥2.1b ÷ (CN¥45b - CN¥12b) (Based on the trailing twelve months to December 2023).
So, Hubei Xingfa Chemicals Group has an ROCE of 6.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.9%.
In the above chart we have measured Hubei Xingfa Chemicals Group'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 analyst report for Hubei Xingfa Chemicals Group .
What Can We Tell From Hubei Xingfa Chemicals Group's ROCE Trend?
When we looked at the ROCE trend at Hubei Xingfa Chemicals Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.3% from 15% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, Hubei Xingfa Chemicals Group has decreased its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. 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.
Our Take On Hubei Xingfa Chemicals Group's ROCE
To conclude, we've found that Hubei Xingfa Chemicals Group is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 82% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Hubei Xingfa Chemicals Group does have some risks, we noticed 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.