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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Long Yuan Construction Group (SHSE:600491) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Long Yuan Construction Group is:

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

0.025 = CN¥746m ÷ (CN¥57b - CN¥28b) (Based on the trailing twelve months to March 2024).

Therefore, Long Yuan Construction Group has an ROCE of 2.5%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.5%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Long Yuan Construction Group'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 Long Yuan Construction Group.

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because Long Yuan Construction Group's ROCE has reduced by 61% over the last five years, while the business employed 39% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Long Yuan Construction Group probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a related note, Long Yuan Construction Group has decreased its current liabilities to 49% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Long Yuan Construction Group's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Long Yuan Construction Group have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 57% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Long Yuan Construction Group does have some risks though, and we've spotted 2 warning signs for Long Yuan Construction Group that you might be interested in.

While Long Yuan Construction Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com