There Are Reasons To Feel Uneasy About Hunan Valin Steel's (SZSE:000932) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 investigating Hunan Valin Steel (SZSE:000932), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed 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)

0.061 = CN¥5.0b ÷ (CN¥151b - CN¥68b) (Based on the trailing twelve months to June 2024).

Thus, Hunan Valin Steel has an ROCE of 6.1%. In absolute terms, that's a low return but it's around the Metals and Mining industry average of 7.0%.

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're interested, you can view the analysts predictions in our free analyst report for Hunan Valin Steel .

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 31%, but since then they've fallen to 6.1%. 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.

Another thing to note, Hunan Valin Steel has a high ratio of current liabilities to total assets of 45%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Hunan Valin Steel's ROCE

In summary, Hunan Valin Steel is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 33% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you'd like to know about the risks facing Hunan Valin Steel, we've discovered 2 warning signs that you should be aware of.

While Hunan Valin Steel isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.