Be Wary Of Hengong Precision Equipment (SZSE:301261) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Hengong Precision Equipment (SZSE:301261) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Hengong Precision Equipment is:

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

0.071 = CN¥125m ÷ (CN¥3.0b - CN¥1.2b) (Based on the trailing twelve months to September 2024).

Therefore, Hengong Precision Equipment has an ROCE of 7.1%. Even though it's in line with the industry average of 6.8%, it's still a low return by itself.

View our latest analysis for Hengong Precision Equipment

In the above chart we have measured Hengong Precision Equipment'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 Hengong Precision Equipment .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Hengong Precision Equipment, we didn't gain much confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 7.1%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, Hengong Precision Equipment has a high ratio of current liabilities to total assets of 40%. 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.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Hengong Precision Equipment. Furthermore the stock has climbed 66% over the last year, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Hengong Precision Equipment does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those don't sit too well with us...

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.