Returns On Capital Signal Tricky Times Ahead For Wuhu Sanlian Forging (SZSE:001282)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Wuhu Sanlian Forging (SZSE:001282) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Wuhu Sanlian Forging is:

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

0.094 = CN¥148m ÷ (CN¥2.1b - CN¥507m) (Based on the trailing twelve months to September 2024).

Therefore, Wuhu Sanlian Forging has an ROCE of 9.4%. In absolute terms, that's a low return, but it's much better than the Auto Components industry average of 7.0%.

View our latest analysis for Wuhu Sanlian Forging

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

So How Is Wuhu Sanlian Forging's ROCE Trending?

When we looked at the ROCE trend at Wuhu Sanlian Forging, we didn't gain much confidence. Around four years ago the returns on capital were 16%, but since then they've fallen to 9.4%. 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, Wuhu Sanlian Forging has done well to pay down its current liabilities to 24% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Wuhu Sanlian Forging's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Wuhu Sanlian Forging is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 28% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know more about Wuhu Sanlian Forging, we've spotted 2 warning signs, and 1 of them is potentially serious.

While Wuhu Sanlian Forging 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.