If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Although, when we looked at Shanghai Tunnel Engineering (SHSE:600820), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Shanghai Tunnel Engineering:

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

0.036 = CN¥2.5b ÷ (CN¥161b - CN¥92b) (Based on the trailing twelve months to March 2024).

Thus, Shanghai Tunnel Engineering has an ROCE of 3.6%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.4%.

In the above chart we have measured Shanghai Tunnel Engineering'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 Shanghai Tunnel Engineering .

What Does the ROCE Trend For Shanghai Tunnel Engineering Tell Us?

When we looked at the ROCE trend at Shanghai Tunnel Engineering, we didn't gain much confidence. To be more specific, ROCE has fallen from 5.2% over the last five years. 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 separate but related note, it's important to know that Shanghai Tunnel Engineering has a current liabilities to total assets ratio of 57%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Shanghai Tunnel Engineering's ROCE

To conclude, we've found that Shanghai Tunnel Engineering is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 41% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you want to know some of the risks facing Shanghai Tunnel Engineering we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.

While Shanghai Tunnel Engineering may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.