Investors Will Want Chaowei Power Holdings' (HKG:951) Growth In ROCE To Persist

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Chaowei Power Holdings, this is the formula:

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).

Thus, 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'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.

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%. The amount of capital employed has increased too, by 30%. So we're very much inspired by what we're seeing at Chaowei Power Holdings thanks to its ability to profitably reinvest capital.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 61% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Bottom Line

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 68% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Chaowei Power Holdings (of which 2 are a bit unpleasant!) that 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.

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.