Hunan Aihua Group (SHSE:603989) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Hunan Aihua Group (SHSE:603989) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Hunan Aihua Group, this is the formula:

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

0.071 = CN¥272m ÷ (CN¥5.8b - CN¥2.0b) (Based on the trailing twelve months to September 2024).

Therefore, Hunan Aihua Group has an ROCE of 7.1%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 5.5%.

View our latest analysis for Hunan Aihua Group

Above you can see how the current ROCE for Hunan Aihua Group 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 Aihua Group .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Hunan Aihua Group doesn't inspire confidence. Around five years ago the returns on capital were 11%, 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.

On a side note, Hunan Aihua Group's current liabilities have increased over the last five years to 34% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 7.1%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On Hunan Aihua Group's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Hunan Aihua Group. However, despite the promising trends, the stock has fallen 32% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Hunan Aihua Group does have some risks though, and we've spotted 2 warning signs for Hunan Aihua Group that you might be interested in.

While Hunan Aihua Group 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.