Returns On Capital Are Showing Encouraging Signs At China Automotive Systems (NASDAQ:CAAS)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at China Automotive Systems (NASDAQ:CAAS) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for China Automotive Systems, this is the formula:

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

0.11 = US$44m ÷ (US$785m - US$380m) (Based on the trailing twelve months to June 2024).

Therefore, China Automotive Systems has an ROCE of 11%. By itself that's a normal return on capital and it's in line with the industry's average returns of 11%.

See our latest analysis for China Automotive Systems

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Automotive Systems' ROCE against it's prior returns. If you're interested in investigating China Automotive Systems' past further, check out this free graph covering China Automotive Systems' past earnings, revenue and cash flow.

So How Is China Automotive Systems' ROCE Trending?

Shareholders will be relieved that China Automotive Systems has broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 11% on its capital. While returns have increased, the amount of capital employed by China Automotive Systems has remained flat over the period. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. Because in the end, a business can only get so efficient.

On a separate but related note, it's important to know that China Automotive Systems has a current liabilities to total assets ratio of 48%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On China Automotive Systems' ROCE

In summary, we're delighted to see that China Automotive Systems has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the stock has returned a staggering 143% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation for CAAS on our platform that is definitely worth checking out.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.