Guangzhou Huayan Precision MachineryLtd (SZSE:301138) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at Guangzhou Huayan Precision MachineryLtd (SZSE:301138) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 Guangzhou Huayan Precision MachineryLtd:

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

0.078 = CN¥86m ÷ (CN¥1.5b - CN¥432m) (Based on the trailing twelve months to September 2024).

Thus, Guangzhou Huayan Precision MachineryLtd has an ROCE of 7.8%. In absolute terms, that's a low return, but it's much better than the Machinery industry average of 5.2%.

Check out our latest analysis for Guangzhou Huayan Precision MachineryLtd

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 Guangzhou Huayan Precision MachineryLtd has performed in the past in other metrics, you can view this free graph of Guangzhou Huayan Precision MachineryLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Guangzhou Huayan Precision MachineryLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.8% from 24% five years ago. 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, Guangzhou Huayan Precision MachineryLtd has decreased its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

While returns have fallen for Guangzhou Huayan Precision MachineryLtd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 48% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Guangzhou Huayan Precision MachineryLtd does have some risks though, and we've spotted 1 warning sign for Guangzhou Huayan Precision MachineryLtd that you might be interested in.

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.