Chaowei Power Holdings (HKG:951) Is Experiencing Growth In Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Chaowei Power Holdings (HKG:951) and its trend of ROCE, we really liked what we saw.

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. The formula for this calculation on Chaowei Power Holdings is:

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

0.13 = CN¥1.0b ÷ (CN¥19b - CN¥12b) (Based on the trailing twelve months to December 2020).

Therefore, Chaowei Power Holdings has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Auto Components industry.

View our latest analysis for Chaowei Power Holdings

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

The Trend Of ROCE

Investors would be pleased with what's happening at Chaowei Power Holdings. The data shows that returns on capital have increased substantially over the last five years to 13%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 43%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a separate but related note, it's important to know that Chaowei Power Holdings has a current liabilities to total assets ratio of 60%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In summary, it's great to see that Chaowei Power Holdings can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 33% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

On a final note, we found 3 warning signs for Chaowei Power Holdings (1 makes us a bit uncomfortable) you should be aware of.

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.

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