Capital Allocation Trends At Rayhoo Motor DiesLtd (SZSE:002997) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Rayhoo Motor DiesLtd (SZSE:002997), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Rayhoo Motor DiesLtd is:

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

0.092 = CN¥245m ÷ (CN¥5.7b - CN¥3.0b) (Based on the trailing twelve months to September 2024).

Thus, Rayhoo Motor DiesLtd has an ROCE of 9.2%. On its own that's a low return, but compared to the average of 5.2% generated by the Machinery industry, it's much better.

Check out our latest analysis for Rayhoo Motor DiesLtd

In the above chart we have measured Rayhoo Motor DiesLtd's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Rayhoo Motor DiesLtd .

The Trend Of ROCE

When we looked at the ROCE trend at Rayhoo Motor DiesLtd, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 9.2%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Rayhoo Motor DiesLtd has decreased its current liabilities to 53% 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. 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. Keep in mind 53% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Rayhoo Motor DiesLtd's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Rayhoo Motor DiesLtd. Furthermore the stock has climbed 91% over the last three years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One final note, you should learn about the 3 warning signs we've spotted with Rayhoo Motor DiesLtd (including 1 which is significant) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.