Investors Could Be Concerned With Hengtong Optic-Electric's (SHSE:600487) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. In light of that, when we looked at Hengtong Optic-Electric (SHSE:600487) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Hengtong Optic-Electric:

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

0.086 = CN¥3.1b ÷ (CN¥63b - CN¥27b) (Based on the trailing twelve months to June 2024).

Thus, Hengtong Optic-Electric has an ROCE of 8.6%. In absolute terms, that's a low return, but it's much better than the Communications industry average of 4.4%.

See our latest analysis for Hengtong Optic-Electric

In the above chart we have measured Hengtong Optic-Electric's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Hengtong Optic-Electric for free.

What Does the ROCE Trend For Hengtong Optic-Electric Tell Us?

On the surface, the trend of ROCE at Hengtong Optic-Electric doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 8.6%. 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, Hengtong Optic-Electric has done well to pay down its current liabilities to 43% of total assets. That could partly explain why the ROCE has dropped. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Hengtong Optic-Electric's ROCE

To conclude, we've found that Hengtong Optic-Electric is reinvesting in the business, but returns have been falling. Unsurprisingly then, the total return to shareholders over the last five years has been flat. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Hengtong Optic-Electric does have some risks though, and we've spotted 1 warning sign for Hengtong Optic-Electric that you might be interested in.

While Hengtong Optic-Electric isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.