Geely Automobile Holdings (HKG:175) May Have Issues Allocating Its Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after investigating Geely Automobile Holdings (HKG:175), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. Analysts use this formula to calculate it for Geely Automobile Holdings:

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

0.002 = CN¥162m ÷ (CN¥141b - CN¥59b) (Based on the trailing twelve months to June 2022).

So, Geely Automobile Holdings has an ROCE of 0.2%. Ultimately, that's a low return and it under-performs the Auto industry average of 1.6%.

Check out our latest analysis for Geely Automobile Holdings

Above you can see how the current ROCE for Geely Automobile Holdings 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 report on analyst forecasts for the company.

What Does the ROCE Trend For Geely Automobile Holdings Tell Us?

On the surface, the trend of ROCE at Geely Automobile Holdings doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 0.2%. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Geely Automobile Holdings has decreased its current liabilities to 42% 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. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Geely Automobile Holdings' 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 Geely Automobile Holdings. These growth trends haven't led to growth returns though, since the stock has fallen 40% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Geely Automobile Holdings does have some risks though, and we've spotted 2 warning signs for Geely Automobile Holdings that you might be interested in.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.