Capital Allocation Trends At Guangzhou Tongda Auto Electric (SHSE:603390) Aren't Ideal

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Guangzhou Tongda Auto Electric (SHSE:603390) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Guangzhou Tongda Auto Electric:

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

0.0083 = CN¥13m ÷ (CN¥1.8b - CN¥183m) (Based on the trailing twelve months to June 2024).

So, Guangzhou Tongda Auto Electric has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 7.4%.

See our latest analysis for Guangzhou Tongda Auto Electric

Historical performance is a great place to start when researching a stock so above you can see the gauge for Guangzhou Tongda Auto Electric'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 Guangzhou Tongda Auto Electric.

So How Is Guangzhou Tongda Auto Electric's ROCE Trending?

When we looked at the ROCE trend at Guangzhou Tongda Auto Electric, we didn't gain much confidence. Around five years ago the returns on capital were 21%, but since then they've fallen to 0.8%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Guangzhou Tongda Auto Electric has decreased its current liabilities to 10% 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Guangzhou Tongda Auto Electric's reinvestment in its own business, we're aware that returns are shrinking. And in the last three years, the stock has given away 15% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Guangzhou Tongda Auto Electric has the makings of a multi-bagger.

One more thing, we've spotted 2 warning signs facing Guangzhou Tongda Auto Electric that you might find interesting.

While Guangzhou Tongda Auto Electric isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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

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.