Capital Allocation Trends At Huali University Group (HKG:1756) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Having said that, from a first glance at Huali University Group (HKG:1756) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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. To calculate this metric for Huali University Group, this is the formula:

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

0.083 = CN¥359m ÷ (CN¥5.1b - CN¥715m) (Based on the trailing twelve months to August 2020).

So, Huali University Group has an ROCE of 8.3%. Even though it's in line with the industry average of 7.8%, it's still a low return by itself.

See our latest analysis for Huali University Group

In the above chart we have measured Huali University Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Huali University Group here for free.

What The Trend Of ROCE Can Tell Us

In terms of Huali University Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 12% over the last four years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Huali University Group has done well to pay down its current liabilities to 14% 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 Huali University Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, total returns to shareholders over the last year have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a final note, we found 2 warning signs for Huali University Group (1 is a bit unpleasant) you should be aware of.

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