Returns On Capital Signal Tricky Times Ahead For Huazhong In-Vehicle Holdings (HKG:6830)

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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Huazhong In-Vehicle Holdings (HKG:6830) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Huazhong In-Vehicle Holdings is:

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

0.074 = CN¥105m ÷ (CN¥3.3b - CN¥1.9b) (Based on the trailing twelve months to June 2021).

Therefore, Huazhong In-Vehicle Holdings has an ROCE of 7.4%. On its own, that's a low figure but it's around the 6.2% average generated by the Auto Components industry.

See our latest analysis for Huazhong In-Vehicle Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Huazhong In-Vehicle Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Huazhong In-Vehicle Holdings' ROCE Trending?

When we looked at the ROCE trend at Huazhong In-Vehicle Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 17% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a separate but related note, it's important to know that Huazhong In-Vehicle Holdings has a current liabilities to total assets ratio of 57%, which we'd consider pretty high. 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.

Our Take On Huazhong In-Vehicle Holdings' ROCE

To conclude, we've found that Huazhong In-Vehicle Holdings is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 418% 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Huazhong In-Vehicle Holdings (of which 1 is a bit concerning!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.