Hunan Oil Pump (SHSE:603319) Is Reinvesting At Lower Rates Of Return

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Hunan Oil Pump (SHSE:603319) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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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. The formula for this calculation on Hunan Oil Pump is:

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

0.082 = CN¥235m ÷ (CN¥3.7b - CN¥883m) (Based on the trailing twelve months to September 2024).

Therefore, Hunan Oil Pump has an ROCE of 8.2%. On its own that's a low return, but compared to the average of 5.3% generated by the Machinery industry, it's much better.

See our latest analysis for Hunan Oil Pump

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hunan Oil Pump.

How Are Returns Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 12% five years ago, while the business's capital employed increased by 198%. Usually this isn't ideal, but given Hunan Oil Pump conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Hunan Oil Pump might not have received a full period of earnings contribution from it. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.

On a side note, Hunan Oil Pump has done well to pay down its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Hunan Oil Pump's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Hunan Oil Pump is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 246% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Hunan Oil Pump (of which 1 shouldn't be ignored!) that you should know about.

While Hunan Oil Pump isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.