Here's What's Concerning About Taiyuan Heavy Industry's (SHSE:600169) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Taiyuan Heavy Industry (SHSE:600169), it didn't seem to tick all of these boxes.

Understanding 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 Taiyuan Heavy Industry:

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

0.059 = CN¥921m ÷ (CN¥32b - CN¥16b) (Based on the trailing twelve months to December 2023).

So, Taiyuan Heavy Industry has an ROCE of 5.9%. Even though it's in line with the industry average of 5.6%, it's still a low return by itself.

View our latest analysis for Taiyuan Heavy Industry

Historical performance is a great place to start when researching a stock so above you can see the gauge for Taiyuan Heavy Industry'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 Taiyuan Heavy Industry.

So How Is Taiyuan Heavy Industry's ROCE Trending?

When we looked at the ROCE trend at Taiyuan Heavy Industry, we didn't gain much confidence. To be more specific, ROCE has fallen from 9.0% over the last five years. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Taiyuan Heavy Industry has decreased its current liabilities to 51% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Taiyuan Heavy Industry's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 29% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

On a final note, we've found 1 warning sign for Taiyuan Heavy Industry that we think you should be aware of.

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.