Investors Could Be Concerned With Jiangsu Hengli HydraulicLtd's (SHSE:601100) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Jiangsu Hengli HydraulicLtd (SHSE:601100), 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. To calculate this metric for Jiangsu Hengli HydraulicLtd, this is the formula:

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

0.15 = CN¥2.3b ÷ (CN¥19b - CN¥3.2b) (Based on the trailing twelve months to March 2024).

Therefore, Jiangsu Hengli HydraulicLtd has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 5.6% it's much better.

See our latest analysis for Jiangsu Hengli HydraulicLtd

In the above chart we have measured Jiangsu Hengli HydraulicLtd'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 Jiangsu Hengli HydraulicLtd .

What The Trend Of ROCE Can Tell Us

In terms of Jiangsu Hengli HydraulicLtd's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 19% 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, Jiangsu Hengli HydraulicLtd has decreased its current liabilities to 17% 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.

The Key Takeaway

To conclude, we've found that Jiangsu Hengli HydraulicLtd is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 139% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Jiangsu Hengli HydraulicLtd (of which 1 is potentially serious!) that you should know about.

While Jiangsu Hengli HydraulicLtd 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.