Returns On Capital Signal Tricky Times Ahead For Hunan Aihua Group (SHSE:603989)

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Hunan Aihua Group (SHSE:603989) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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 Hunan Aihua Group is:

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

0.082 = CN¥311m ÷ (CN¥5.5b - CN¥1.8b) (Based on the trailing twelve months to March 2024).

Thus, Hunan Aihua Group has an ROCE of 8.2%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 5.2%.

View our latest analysis for Hunan Aihua Group

In the above chart we have measured Hunan Aihua Group'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 Hunan Aihua Group for free.

How Are Returns Trending?

In terms of Hunan Aihua Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 12% over the last five years. 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, Hunan Aihua Group's current liabilities have increased over the last five years to 32% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 8.2%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

To conclude, we've found that Hunan Aihua Group is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 22% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Hunan Aihua Group has the makings of a multi-bagger.

On a final note, we've found 2 warning signs for Hunan Aihua Group that we think you should be aware of.

While Hunan Aihua Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.