There Are Reasons To Feel Uneasy About Huadi International Group's (NASDAQ:HUDI) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Huadi International Group (NASDAQ:HUDI), it didn't seem to tick all of these boxes.

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. 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)

0.05 = US$2.6m ÷ (US$100m - US$49m) (Based on the trailing twelve months to September 2021).

So, Huadi International Group has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 20%.

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 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?

In terms of Huadi International Group's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 42%, but since then they've fallen to 5.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Huadi International Group has done well to pay down its current liabilities to 49% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

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 the stock has done incredibly well with a 325% return over the last year, so long term investors are no doubt ecstatic with that result. 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.

On a final note, we found 4 warning signs for Huadi International Group (2 are concerning) you should be aware of.

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.