Be Wary Of Weihai Honglin Electronic (SZSE:301439) And Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. However, after briefly looking over the numbers, we don't think Weihai Honglin Electronic (SZSE:301439) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Weihai Honglin Electronic is:

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

0.032 = CN¥94m ÷ (CN¥4.1b - CN¥1.1b) (Based on the trailing twelve months to September 2024).

Thus, Weihai Honglin Electronic has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Electrical industry average of 5.8%.

View our latest analysis for Weihai Honglin Electronic

Historical performance is a great place to start when researching a stock so above you can see the gauge for Weihai Honglin Electronic's ROCE against it's prior returns. If you'd like to look at how Weihai Honglin Electronic has performed in the past in other metrics, you can view this free graph of Weihai Honglin Electronic's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Weihai Honglin Electronic, we didn't gain much confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 3.2%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Weihai Honglin Electronic has decreased its current liabilities to 28% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Weihai Honglin Electronic is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 89% to shareholders over the last year. 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.

Weihai Honglin Electronic does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.