Capital Allocation Trends At Huadi International Group (NASDAQ:HUDI) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Huadi International Group (NASDAQ:HUDI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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. Analysts use this formula to calculate it for Huadi International Group:

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

0.044 = US$2.6m ÷ (US$91m - US$32m) (Based on the trailing twelve months to March 2022).

So, Huadi International Group has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 21%.

See our latest analysis for Huadi International Group

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Huadi International Group's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Huadi International Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 46% over the last four years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Huadi International Group has decreased its current liabilities to 35% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Huadi International Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Huadi International Group is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 757% to shareholders in the last year. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Huadi International Group does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

While Huadi International Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.