First Tractor (HKG:38) Is Experiencing Growth In Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at First Tractor (HKG:38) and its trend of ROCE, we really liked what we saw.

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 First Tractor is:

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

0.10 = CN¥764m ÷ (CN¥14b - CN¥6.9b) (Based on the trailing twelve months to June 2023).

So, First Tractor has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 7.9% it's much better.

View our latest analysis for First Tractor

Above you can see how the current ROCE for First Tractor compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering First Tractor here for free.

So How Is First Tractor's ROCE Trending?

We're delighted to see that First Tractor is reaping rewards from its investments and has now broken into profitability. The company now earns 10% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.

On a side note, First Tractor's current liabilities are still rather high at 49% of total assets. 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...

To sum it up, First Tractor is collecting higher returns from the same amount of capital, and that's impressive. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a separate note, we've found 1 warning sign for First Tractor you'll probably want to know about.

While First Tractor isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.