There Are Reasons To Feel Uneasy About West Shanghai Automotive ServiceLtd's (SHSE:605151) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at West Shanghai Automotive ServiceLtd (SHSE:605151), it didn't seem to tick all of these boxes.

Understanding 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. The formula for this calculation on West Shanghai Automotive ServiceLtd is:

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

0.056 = CN¥98m ÷ (CN¥2.7b - CN¥931m) (Based on the trailing twelve months to September 2024).

Therefore, West Shanghai Automotive ServiceLtd has an ROCE of 5.6%. In absolute terms, that's a low return but it's around the Auto Components industry average of 7.0%.

Check out our latest analysis for West Shanghai Automotive ServiceLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for West Shanghai Automotive ServiceLtd's ROCE against it's prior returns. If you're interested in investigating West Shanghai Automotive ServiceLtd's past further, check out this free graph covering West Shanghai Automotive ServiceLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of West Shanghai Automotive ServiceLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 22%, but since then they've fallen to 5.6%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, West Shanghai Automotive ServiceLtd has done well to pay down its current liabilities to 35% of total assets. That could partly explain why the ROCE has dropped. 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 On West Shanghai Automotive ServiceLtd's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that West Shanghai Automotive ServiceLtd is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 11% gain to shareholders who've held over the last three years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

West Shanghai Automotive ServiceLtd does have some risks though, and we've spotted 2 warning signs for West Shanghai Automotive ServiceLtd that you might be interested in.

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.