Changchun FAWAY Automobile ComponentsLtd (SHSE:600742) Will Be Hoping To Turn Its Returns On Capital Around

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Changchun FAWAY Automobile ComponentsLtd (SHSE:600742) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Changchun FAWAY Automobile ComponentsLtd:

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

0.034 = CN¥377m ÷ (CN¥22b - CN¥11b) (Based on the trailing twelve months to September 2024).

So, Changchun FAWAY Automobile ComponentsLtd has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 7.0%.

See our latest analysis for Changchun FAWAY Automobile ComponentsLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Changchun FAWAY Automobile ComponentsLtd's ROCE against it's prior returns. If you'd like to look at how Changchun FAWAY Automobile ComponentsLtd has performed in the past in other metrics, you can view this free graph of Changchun FAWAY Automobile ComponentsLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Changchun FAWAY Automobile ComponentsLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 5.2%, but since then they've fallen to 3.4%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 50%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.4%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

Our Take On Changchun FAWAY Automobile ComponentsLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Changchun FAWAY Automobile ComponentsLtd's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 10% 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Changchun FAWAY Automobile ComponentsLtd (of which 1 can't be ignored!) that you should know about.

While Changchun FAWAY Automobile ComponentsLtd 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.

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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.