What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. In light of that, when we looked at Shanghai Pharmaceuticals Holding (SHSE:601607) 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 Shanghai Pharmaceuticals Holding, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.098 = CN¥8.9b ÷ (CN¥213b - CN¥122b) (Based on the trailing twelve months to September 2023).
Therefore, Shanghai Pharmaceuticals Holding has an ROCE of 9.8%. On its own, that's a low figure but it's around the 11% average generated by the Healthcare industry.
Above you can see how the current ROCE for Shanghai Pharmaceuticals Holding compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Shanghai Pharmaceuticals Holding for free.
What Does the ROCE Trend For Shanghai Pharmaceuticals Holding Tell Us?
In terms of Shanghai Pharmaceuticals Holding's historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 9.8% for the last five years, and the capital employed within the business has risen 78% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
On a side note, Shanghai Pharmaceuticals Holding's current liabilities are still rather high at 57% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
In Conclusion...
In summary, Shanghai Pharmaceuticals Holding has simply been reinvesting capital and generating the same low rate of return as before. And with the stock having returned a mere 8.1% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
If you're still interested in Shanghai Pharmaceuticals Holding it's worth checking out our FREE intrinsic value approximation for 601607 to see if it's trading at an attractive price in other respects.
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.