Returns On Capital Signal Difficult Times Ahead For China Automotive Systems (NASDAQ:CAAS)

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at China Automotive Systems (NASDAQ:CAAS), we've spotted some signs that it could be struggling, so let's investigate.

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

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 China Automotive Systems:

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

0.0027 = US$972k ÷ (US$686m - US$332m) (Based on the trailing twelve months to September 2021).

So, China Automotive Systems has an ROCE of 0.3%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 8.4%.

View our latest analysis for China Automotive Systems

In the above chart we have measured China Automotive Systems' 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 China Automotive Systems here for free.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at China Automotive Systems. About five years ago, returns on capital were 8.0%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on China Automotive Systems becoming one if things continue as they have.

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 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On China Automotive Systems' ROCE

In summary, it's unfortunate that China Automotive Systems is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 44% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing, we've spotted 1 warning sign facing China Automotive Systems that you might find interesting.

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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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.