Huali University Group (HKG:1756) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Huali University Group (HKG:1756) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Huali University Group is:

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

0.082 = CN¥382m ÷ (CN¥5.6b - CN¥923m) (Based on the trailing twelve months to February 2021).

So, Huali University Group has an ROCE of 8.2%. On its own, that's a low figure but it's around the 7.3% average generated by the Consumer Services industry.

Check out 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Huali University Group's ROCE Trending?

In terms of Huali University Group's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Huali University Group has decreased its current liabilities to 16% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Huali University Group's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Huali University Group. However, despite the promising trends, the stock has fallen 35% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified 2 warning signs with Huali University Group (at least 1 which is potentially serious) , and understanding them would certainly be useful.

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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