Chaowei Power Holdings (HKG:951) Is Looking To Continue Growing Its Returns On 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Chaowei Power Holdings' (HKG:951) returns on capital, so let's have a 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 Chaowei Power Holdings is:

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

0.12 = CN¥982m ÷ (CN¥21b - CN¥13b) (Based on the trailing twelve months to June 2021).

Therefore, Chaowei Power Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Auto Components industry average of 6.2% it's much better.

Check out 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're interested in investigating Chaowei Power Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Chaowei Power Holdings' ROCE Trend?

Investors would be pleased with what's happening at Chaowei Power Holdings. Over the last five years, returns on capital employed have risen substantially to 12%. Basically the business is earning more per dollar of capital invested and in addition to that, 30% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 61% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Bottom Line

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Chaowei Power Holdings has. Given the stock has declined 68% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

Chaowei Power Holdings does have some risks, we noticed 4 warning signs (and 2 which can't be ignored) we think you should know about.

While Chaowei Power 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.

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.

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