Investors Could Be Concerned With Hongli Group's (NASDAQ:HLP) Returns On Capital

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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Hongli Group (NASDAQ:HLP) 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 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. Analysts use this formula to calculate it for Hongli Group:

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

0.042 = US$1.0m ÷ (US$32m - US$7.7m) (Based on the trailing twelve months to December 2023).

Thus, Hongli Group has an ROCE of 4.2%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 8.8%.

See our latest analysis for Hongli Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hongli Group's ROCE against it's prior returns. If you'd like to look at how Hongli Group has performed in the past in other metrics, you can view this free graph of Hongli Group's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Hongli Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 55% over the last four years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Hongli Group has decreased its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Hongli Group's ROCE

In summary, we're somewhat concerned by Hongli Group's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 48% over the last year, 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 identified 4 warning signs with Hongli Group (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

While Hongli Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com