Investors Could Be Concerned With Hebei Yichen Industrial Group's (HKG:1596) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Having said that, from a first glance at Hebei Yichen Industrial Group (HKG:1596) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Hebei Yichen Industrial Group:

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

0.10 = CN¥234m ÷ (CN¥3.1b - CN¥774m) (Based on the trailing twelve months to June 2021).

So, Hebei Yichen Industrial Group has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 9.0% generated by the Machinery industry.

Check out our latest analysis for Hebei Yichen Industrial Group

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 Hebei Yichen Industrial Group's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Hebei Yichen Industrial Group's ROCE Trend?

On the surface, the trend of ROCE at Hebei Yichen Industrial Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 10% from 34% five years ago. However it looks like Hebei Yichen Industrial Group 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.

On a side note, Hebei Yichen Industrial Group has done well to pay down its current liabilities to 25% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Hebei Yichen Industrial Group's ROCE

Bringing it all together, while we're somewhat encouraged by Hebei Yichen Industrial Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 17% over the last three years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One more thing, we've spotted 1 warning sign facing Hebei Yichen Industrial Group that you might find interesting.

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.

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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