If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Hunan Haili Chemical IndustryLtd (SHSE:600731), it didn't seem to tick all of these boxes.

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 Hunan Haili Chemical IndustryLtd:

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

0.032 = CN¥118m ÷ (CN¥4.3b - CN¥570m) (Based on the trailing twelve months to June 2024).

Therefore, Hunan Haili Chemical IndustryLtd has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hunan Haili Chemical IndustryLtd's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hunan Haili Chemical IndustryLtd.

What Does the ROCE Trend For Hunan Haili Chemical IndustryLtd Tell Us?

On the surface, the trend of ROCE at Hunan Haili Chemical IndustryLtd doesn't inspire confidence. To be more specific, ROCE has fallen from 22% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Hunan Haili Chemical IndustryLtd has done well to pay down its current liabilities to 13% 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.

The Bottom Line On Hunan Haili Chemical IndustryLtd's ROCE

In summary, we're somewhat concerned by Hunan Haili Chemical IndustryLtd's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 17% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Hunan Haili Chemical IndustryLtd does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) 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.

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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.