Returns On Capital At Hongfa Technology (SHSE:600885) Have Hit The Brakes

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. With that in mind, the ROCE of Hongfa Technology (SHSE:600885) looks decent, right now, so lets see what the trend of returns can tell us.

Understanding Return On Capital Employed (ROCE)

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)

0.16 = CN¥2.3b ÷ (CN¥18b - CN¥3.8b) (Based on the trailing twelve months to March 2024).

Thus, Hongfa Technology has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 6.0% generated by the Electrical industry.

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 to see what analysts are forecasting going forward, you should check out our free analyst report for Hongfa Technology .

How Are Returns Trending?

While the returns on capital are good, they haven't moved much. The company has employed 122% more capital in the last five years, and the returns on that capital have remained stable at 16%. Since 16% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. 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.

On a side note, Hongfa Technology has done well to reduce current liabilities to 21% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

In Conclusion...

The main thing to remember is that Hongfa Technology has proven its ability to continually reinvest at respectable rates of return. Therefore it's no surprise that shareholders have earned a respectable 57% return if they held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

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

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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com