Huadian Heavy Industries (SHSE:601226) May Have Issues Allocating Its Capital

Did you know there are some financial metrics that can provide clues of a potential 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. Having said that, from a first glance at Huadian Heavy Industries (SHSE:601226) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Huadian Heavy Industries is:

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

0.019 = CN¥83m ÷ (CN¥10b - CN¥5.6b) (Based on the trailing twelve months to June 2024).

So, Huadian Heavy Industries has an ROCE of 1.9%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 5.7%.

See our latest analysis for Huadian Heavy Industries

Above you can see how the current ROCE for Huadian Heavy Industries compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Huadian Heavy Industries .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Huadian Heavy Industries doesn't inspire confidence. To be more specific, ROCE has fallen from 2.4% over the last five years. However it looks like Huadian Heavy Industries might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

Another thing to note, Huadian Heavy Industries has a high ratio of current liabilities to total assets of 56%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

To conclude, we've found that Huadian Heavy Industries is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 40% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you want to continue researching Huadian Heavy Industries, you might be interested to know about the 2 warning signs that our analysis has discovered.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.