Investors Could Be Concerned With Huadi International Group's (NASDAQ:HUDI) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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 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.

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

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. To calculate this metric for Huadi International Group, this is the formula:

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

0.031 = US$1.5m ÷ (US$93m - US$44m) (Based on the trailing twelve months to March 2021).

Thus, Huadi International Group has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 17%.

Check out 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 want to delve into the historical earnings, revenue and cash flow of Huadi International Group, check out these free graphs here.

What Can We Tell From Huadi International Group's ROCE Trend?

On the surface, the trend of ROCE at Huadi International Group doesn't inspire confidence. To be more specific, ROCE has fallen from 46% over the last three years. However it looks like Huadi International Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Huadi International Group has done well to pay down its current liabilities to 47% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Huadi International Group's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 214% gain to shareholders who have held over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 4 warning signs we've spotted with Huadi International Group (including 1 which can't be ignored) .

While Huadi International 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.

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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.