The Returns On Capital At Huayu Expressway Group (HKG:1823) Don't Inspire Confidence

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Huayu Expressway Group (HKG:1823) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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 Huayu Expressway Group is:

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

0.081 = HK$135m ÷ (HK$1.9b - HK$203m) (Based on the trailing twelve months to December 2020).

Therefore, Huayu Expressway Group has an ROCE of 8.1%. In absolute terms, that's a low return but it's around the Construction industry average of 9.4%.

Check out our latest analysis for Huayu Expressway Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Huayu Expressway Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Huayu Expressway Group, check out these free graphs here.

So How Is Huayu Expressway Group's ROCE Trending?

On the surface, the trend of ROCE at Huayu Expressway Group doesn't inspire confidence. To be more specific, ROCE has fallen from 11% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Huayu Expressway Group has decreased its current liabilities to 11% of total assets. So we could link some of this to the decrease in ROCE. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

While returns have fallen for Huayu Expressway Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 182% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you want to know some of the risks facing Huayu Expressway Group we've found 3 warning signs (1 can't be ignored!) that you should be aware of before investing here.

While Huayu Expressway Group 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.

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