Xiwang Special Steel (HKG:1266) Will Will Want To Turn Around Its Return Trends

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Xiwang Special Steel (HKG:1266) 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. Analysts use this formula to calculate it for Xiwang Special Steel:

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

0.027 = CN¥188m ÷ (CN¥15b - CN¥8.3b) (Based on the trailing twelve months to December 2020).

Thus, Xiwang Special Steel has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 8.1%.

Check out our latest analysis for Xiwang Special Steel

Historical performance is a great place to start when researching a stock so above you can see the gauge for Xiwang Special Steel's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Xiwang Special Steel, check out these free graphs here.

What Can We Tell From Xiwang Special Steel's ROCE Trend?

When we looked at the ROCE trend at Xiwang Special Steel, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.7% from 4.8% 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.

Another thing to note, Xiwang Special Steel has a high ratio of current liabilities to total assets of 54%. 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...

In summary, despite lower returns in the short term, we're encouraged to see that Xiwang Special Steel is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 42% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Xiwang Special Steel does have some risks though, and we've spotted 2 warning signs for Xiwang Special Steel that you might be interested in.

While Xiwang Special Steel 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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