Returns On Capital Are Showing Encouraging Signs At Weihai Huadong Automation (SZSE:002248)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Speaking of which, we noticed some great changes in Weihai Huadong Automation's (SZSE:002248) returns on capital, so let's have a 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 Weihai Huadong Automation is:

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

0.052 = CN¥7.6m ÷ (CN¥543m - CN¥398m) (Based on the trailing twelve months to September 2023).

Thus, Weihai Huadong Automation has an ROCE of 5.2%. In absolute terms, that's a low return but it's around the Machinery industry average of 5.6%.

See our latest analysis for Weihai Huadong Automation

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'd like to look at how Weihai Huadong Automation has performed in the past in other metrics, you can view this free graph of Weihai Huadong Automation's past earnings, revenue and cash flow.

What Does the ROCE Trend For Weihai Huadong Automation Tell Us?

Like most people, we're pleased that Weihai Huadong Automation is now generating some pretax earnings. While the business is profitable now, it used to be incurring losses on invested capital five years ago. In regards to capital employed, Weihai Huadong Automation is using 71% less capital than it was five years ago, which on the surface, can indicate that the business has become more efficient at generating these returns. Weihai Huadong Automation could be selling under-performing assets since the ROCE is improving.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 73% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Bottom Line

In the end, Weihai Huadong Automation has proven it's capital allocation skills are good with those higher returns from less amount of capital. Given the stock has declined 27% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we found 4 warning signs for Weihai Huadong Automation (1 shouldn't be ignored) you should be aware of.

While Weihai Huadong Automation 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.

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