Be Wary Of HIT Welding IndustryLtd (SZSE:301137) And Its Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at HIT Welding IndustryLtd (SZSE:301137) 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. Analysts use this formula to calculate it for HIT Welding IndustryLtd:

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

0.02 = CN¥27m ÷ (CN¥2.0b - CN¥659m) (Based on the trailing twelve months to June 2024).

Therefore, HIT Welding IndustryLtd has an ROCE of 2.0%. Ultimately, that's a low return and it under-performs the Machinery industry average of 5.5%.

See our latest analysis for HIT Welding IndustryLtd

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 HIT Welding IndustryLtd.

What Can We Tell From HIT Welding IndustryLtd's ROCE Trend?

On the surface, the trend of ROCE at HIT Welding IndustryLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.0% from 14% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, HIT Welding IndustryLtd has done well to pay down its current liabilities to 32% 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by HIT Welding IndustryLtd's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 20% over the last year, 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.

One more thing: We've identified 4 warning signs with HIT Welding IndustryLtd (at least 2 which are a bit unpleasant) , and understanding these would certainly be useful.

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.

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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.