If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Long Yuan Construction Group (SHSE:600491), it didn't seem to tick all of these boxes.

Understanding 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. 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)

0.011 = CN¥360m ÷ (CN¥61b - CN¥29b) (Based on the trailing twelve months to September 2023).

Therefore, Long Yuan Construction Group has an ROCE of 1.1%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.8%.

Check out our latest analysis for Long Yuan Construction Group

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're interested in investigating Long Yuan Construction Group's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Long Yuan Construction Group's ROCE Trend?

We weren't thrilled with the trend because Long Yuan Construction Group's ROCE has reduced by 83% over the last five years, while the business employed 71% more capital. Usually this isn't ideal, but given Long Yuan Construction Group conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. 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 side note, Long Yuan Construction Group has done well to pay down its current liabilities to 48% 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. Keep in mind 48% is still pretty high, so those risks are still somewhat prevalent.

What We Can Learn From 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. Long term shareholders who've owned the stock over the last five years have experienced a 45% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing, we've spotted 2 warning signs facing Long Yuan Construction Group that you might find interesting.

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.