Investors Will Want First Tractor's (HKG:38) Growth In ROCE To Persist

There are a few key trends to look for if we want to identify the next multi-bagger. 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. With that in mind, we've noticed some promising trends at First Tractor (HKG:38) so let's look a bit deeper.

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. To calculate this metric for First Tractor, this is the formula:

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

0.07 = CN¥455m ÷ (CN¥13b - CN¥6.3b) (Based on the trailing twelve months to March 2021).

So, First Tractor has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.1%.

See our latest analysis for First Tractor

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 First Tractor's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From First Tractor's ROCE Trend?

First Tractor's ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 93% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

On a separate but related note, it's important to know that First Tractor has a current liabilities to total assets ratio of 49%, which we'd consider pretty high. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On First Tractor's ROCE

To sum it up, First Tractor is collecting higher returns from the same amount of capital, and that's impressive. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 15% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One more thing to note, we've identified 3 warning signs with First Tractor and understanding these should be part of your investment process.

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.
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