Capital Allocation Trends At Weichai Power (HKG:2338) Aren't Ideal
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Weichai Power (HKG:2338), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on Weichai Power is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.015 = CN¥2.6b ÷ (CN¥295b - CN¥126b) (Based on the trailing twelve months to September 2022).
Therefore, Weichai Power has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 7.0%.
View our latest analysis for Weichai Power
In the above chart we have measured Weichai Power's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Weichai Power's ROCE Trending?
When we looked at the ROCE trend at Weichai Power, we didn't gain much confidence. Around five years ago the returns on capital were 8.8%, but since then they've fallen to 1.5%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
Another thing to note, Weichai Power has a high ratio of current liabilities to total assets of 43%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
In summary, we're somewhat concerned by Weichai Power's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 54% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
On a separate note, we've found 2 warning signs for Weichai Power you'll probably want to know about.
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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.
Weichai Power Co., Ltd. manufactures and sells diesel engines, automobiles, and other automobile components in China and internationally.
Excellent balance sheet with reasonable growth potential.