There Are Reasons To Feel Uneasy About Zhuhai Huajin Capital's (SZSE:000532) 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? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Zhuhai Huajin Capital (SZSE:000532), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Zhuhai Huajin Capital is:

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

0.05 = CN¥87m ÷ (CN¥2.4b - CN¥655m) (Based on the trailing twelve months to March 2024).

So, Zhuhai Huajin Capital has an ROCE of 5.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.2%.

View our latest analysis for Zhuhai Huajin Capital

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhuhai Huajin Capital's ROCE against it's prior returns. If you'd like to look at how Zhuhai Huajin Capital has performed in the past in other metrics, you can view this free graph of Zhuhai Huajin Capital's past earnings, revenue and cash flow.

What Does the ROCE Trend For Zhuhai Huajin Capital Tell Us?

On the surface, the trend of ROCE at Zhuhai Huajin Capital doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.0% from 12% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Zhuhai Huajin Capital has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Zhuhai Huajin Capital have fallen, meanwhile the business is employing more capital than it was five years ago. Despite the concerning underlying trends, the stock has actually gained 37% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a final note, we've found 1 warning sign for Zhuhai Huajin Capital that we think you should be aware of.

While Zhuhai Huajin Capital 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.