Returns On Capital At Weichai Power (HKG:2338) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. However, after briefly looking over the numbers, we don't think Weichai Power (HKG:2338) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Weichai Power is:

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

0.057 = CN¥10b ÷ (CN¥325b - CN¥142b) (Based on the trailing twelve months to September 2023).

Therefore, Weichai Power has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Machinery industry average of 7.4%.

See our latest analysis for Weichai Power

Above you can see how the current ROCE for Weichai Power compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Weichai Power.

What Can We Tell From Weichai Power's ROCE Trend?

On the surface, the trend of ROCE at Weichai Power doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.7% from 11% five years ago. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that Weichai Power has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Weichai Power. Furthermore the stock has climbed 72% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you'd like to know about the risks facing Weichai Power, we've discovered 1 warning sign that you should be aware of.

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.

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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.