Returns On Capital Signal Tricky Times Ahead For Weihai Honglin Electronic (SZSE:301439)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. 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)

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 Weihai Honglin Electronic:

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

0.036 = CN¥103m ÷ (CN¥3.6b - CN¥727m) (Based on the trailing twelve months to March 2024).

Thus, Weihai Honglin Electronic has an ROCE of 3.6%. Ultimately, that's a low return and it under-performs the Electrical industry average of 6.0%.

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Weihai Honglin Electronic.

What Can We Tell From Weihai Honglin Electronic's ROCE Trend?

On the surface, the trend of ROCE at Weihai Honglin Electronic doesn't inspire confidence. To be more specific, ROCE has fallen from 23% over the last five years. 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, Weihai Honglin Electronic has done well to pay down its current liabilities to 20% 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.

Our Take On Weihai Honglin Electronic's ROCE

In summary, Weihai Honglin Electronic is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last year, the stock has given away 29% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Weihai Honglin Electronic does have some risks, we noticed 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.