Hwaxin EnvironmentalLtd's (SZSE:301265) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 investigating Hwaxin EnvironmentalLtd (SZSE:301265), we don't think it's current trends fit the mold of a multi-bagger.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Hwaxin EnvironmentalLtd is:

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

0.042 = CN¥91m ÷ (CN¥2.3b - CN¥77m) (Based on the trailing twelve months to September 2023).

Therefore, Hwaxin EnvironmentalLtd has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 5.5%.

See our latest analysis for Hwaxin EnvironmentalLtd

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 Hwaxin EnvironmentalLtd has performed in the past in other metrics, you can view this free graph of Hwaxin EnvironmentalLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Hwaxin EnvironmentalLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.2% from 11% 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Hwaxin EnvironmentalLtd has done well to pay down its current liabilities to 3.4% 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. 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 On Hwaxin EnvironmentalLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Hwaxin EnvironmentalLtd's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 27% over the last year, investors may not be too optimistic on this trend improving either. 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.

Hwaxin EnvironmentalLtd does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) 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.

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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.