We Like These Underlying Return On Capital Trends At Li Auto (NASDAQ:LI)

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. 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. With that in mind, we've noticed some promising trends at Li Auto (NASDAQ:LI) so let's look a bit deeper.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Li Auto is:

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

0.068 = CN¥4.2b ÷ (CN¥120b - CN¥58b) (Based on the trailing twelve months to September 2023).

Thus, Li Auto has an ROCE of 6.8%. In absolute terms, that's a low return and it also under-performs the Auto industry average of 9.7%.

View our latest analysis for Li Auto

In the above chart we have measured Li Auto'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 Li Auto here for free.

The Trend Of ROCE

We're delighted to see that Li Auto is reaping rewards from its investments and is now generating some pre-tax profits. About four years ago the company was generating losses but things have turned around because it's now earning 6.8% on its capital. In addition to that, Li Auto is employing 880% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 48% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

In Conclusion...

To the delight of most shareholders, Li Auto has now broken into profitability. Investors may not be impressed by the favorable underlying trends yet because over the last three years the stock has only returned 19% to shareholders. So with that in mind, we think the stock deserves further research.

One more thing, we've spotted 1 warning sign facing Li Auto that you might find interesting.

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.