Here's What To Make Of Hongfa Technology's (SHSE:600885) Decelerating Rates Of Return

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So, when we ran our eye over Hongfa Technology's (SHSE:600885) trend of ROCE, we liked what we saw.

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. To calculate this metric for Hongfa Technology, this is the formula:

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

0.15 = CN¥2.4b ÷ (CN¥21b - CN¥5.0b) (Based on the trailing twelve months to September 2024).

Therefore, Hongfa Technology has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Electrical industry average of 5.8% it's much better.

See our latest analysis for Hongfa Technology

Above you can see how the current ROCE for Hongfa Technology compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Hongfa Technology .

What Can We Tell From Hongfa Technology's ROCE Trend?

While the returns on capital are good, they haven't moved much. The company has consistently earned 15% for the last five years, and the capital employed within the business has risen 132% in that time. 15% is a pretty standard return, and it provides some comfort knowing that Hongfa Technology has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 24% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

Our Take On Hongfa Technology's ROCE

In the end, Hongfa Technology has proven its ability to adequately reinvest capital at good rates of return. In light of this, the stock has only gained 26% over the last five years for shareholders who have owned the stock in this period. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.

One more thing to note, we've identified 1 warning sign with Hongfa Technology and understanding it should be part of your investment process.

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.