Huazhong In-Vehicle Holdings (HKG:6830) Will Be Hoping To Turn Its Returns On Capital Around

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Although, when we looked at Huazhong In-Vehicle Holdings (HKG:6830), it didn't seem to tick all of these boxes.

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 Huazhong In-Vehicle Holdings:

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

0.073 = CN¥101m ÷ (CN¥3.2b - CN¥1.9b) (Based on the trailing twelve months to December 2020).

So, Huazhong In-Vehicle Holdings has an ROCE of 7.3%. On its own, that's a low figure but it's around the 8.4% average generated by the Auto Components industry.

See our latest analysis for Huazhong In-Vehicle Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Huazhong In-Vehicle Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Huazhong In-Vehicle Holdings, check out these free graphs here.

The Trend Of ROCE

When we looked at the ROCE trend at Huazhong In-Vehicle Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 7.3%. However it looks like Huazhong In-Vehicle Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

Another thing to note, Huazhong In-Vehicle Holdings has a high ratio of current liabilities to total assets of 57%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Huazhong In-Vehicle Holdings' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 158% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing: We've identified 3 warning signs with Huazhong In-Vehicle Holdings (at least 1 which can't be ignored) , and understanding them would certainly be useful.

While Huazhong In-Vehicle Holdings 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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