Hunan Valin Steel (SZSE:000932) Is Reinvesting At Lower Rates Of Return

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Hunan Valin Steel (SZSE:000932) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Hunan Valin Steel is:

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

0.093 = CN¥7.3b ÷ (CN¥131b - CN¥51b) (Based on the trailing twelve months to September 2023).

Therefore, Hunan Valin Steel has an ROCE of 9.3%. On its own that's a low return, but compared to the average of 6.5% generated by the Metals and Mining industry, it's much better.

See our latest analysis for Hunan Valin Steel

In the above chart we have measured Hunan Valin Steel's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Hunan Valin Steel .

How Are Returns Trending?

When we looked at the ROCE trend at Hunan Valin Steel, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 9.3% from 34% five years ago. 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 side note, Hunan Valin Steel has done well to pay down its current liabilities to 39% 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.

What We Can Learn From Hunan Valin Steel's ROCE

Bringing it all together, while we're somewhat encouraged by Hunan Valin Steel's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 24% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

On a final note, we've found 1 warning sign for Hunan Valin Steel that we think 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.