Hongfa Technology's (SHSE:600885) Returns On Capital Not Reflecting Well On The Business

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. In light of that, when we looked at Hongfa Technology (SHSE:600885) and its ROCE trend, we weren't exactly thrilled.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Hongfa Technology is:

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

0.14 = CN¥2.0b ÷ (CN¥18b - CN¥3.9b) (Based on the trailing twelve months to September 2023).

Thus, Hongfa Technology has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Electrical industry average of 6.3% it's much better.

See our latest analysis for Hongfa Technology

In the above chart we have measured Hongfa Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Hongfa Technology for free.

The Trend Of ROCE

In terms of Hongfa Technology's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 18% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Hongfa Technology's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Hongfa Technology. In light of this, the stock has only gained 37% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Like most companies, Hongfa Technology does come with some risks, and we've found 1 warning sign that you should be aware of.

While Hongfa Technology 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.

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.