XCMG Construction Machinery's (SZSE:000425) Returns Have Hit A Wall

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at XCMG Construction Machinery (SZSE:000425) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for XCMG Construction Machinery, this is the formula:

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

0.083 = CN¥6.5b ÷ (CN¥166b - CN¥88b) (Based on the trailing twelve months to June 2024).

So, XCMG Construction Machinery has an ROCE of 8.3%. In absolute terms, that's a low return, but it's much better than the Machinery industry average of 5.5%.

Check out our latest analysis for XCMG Construction Machinery

Above you can see how the current ROCE for XCMG Construction Machinery compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering XCMG Construction Machinery for free.

The Trend Of ROCE

In terms of XCMG Construction Machinery's historical ROCE trend, it doesn't exactly demand attention. Over the past five years, ROCE has remained relatively flat at around 8.3% and the business has deployed 115% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

Another thing to note, XCMG Construction Machinery has a high ratio of current liabilities to total assets of 53%. 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.

In Conclusion...

Long story short, while XCMG Construction Machinery has been reinvesting its capital, the returns that it's generating haven't increased. Since the stock has gained an impressive 55% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to continue researching XCMG Construction Machinery, you might be interested to know about the 2 warning signs that our analysis has discovered.

While XCMG Construction Machinery 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.