Hunan Valin Steel (SZSE:000932) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Hunan Valin Steel (SZSE:000932), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Hunan Valin Steel:

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

0.047 = CN¥3.9b ÷ (CN¥159b - CN¥77b) (Based on the trailing twelve months to September 2024).

So, Hunan Valin Steel has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 6.8%.

Check out our latest analysis for Hunan Valin Steel

Above you can see how the current ROCE for Hunan Valin Steel compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Hunan Valin Steel for free.

What Does the ROCE Trend For Hunan Valin Steel Tell Us?

On the surface, the trend of ROCE at Hunan Valin Steel doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 4.7%. However it looks like Hunan Valin Steel might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a separate but related note, it's important to know that Hunan Valin Steel has a current liabilities to total assets ratio of 48%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

To conclude, we've found that Hunan Valin Steel is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 45% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Like most companies, Hunan Valin Steel does come with some risks, and we've found 3 warning signs that you should be aware of.

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.