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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Changhong Huayi Compressor (SZSE:000404) and its trend of ROCE, we really liked what we saw.
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 Changhong Huayi Compressor is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = CN¥489m ÷ (CN¥14b - CN¥8.0b) (Based on the trailing twelve months to December 2023).
Therefore, Changhong Huayi Compressor has an ROCE of 8.3%. In absolute terms, that's a low return, but it's much better than the Machinery industry average of 6.1%.
In the above chart we have measured Changhong Huayi Compressor'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 Changhong Huayi Compressor for free.
So How Is Changhong Huayi Compressor's ROCE Trending?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 8.3%. The amount of capital employed has increased too, by 34%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
Another thing to note, Changhong Huayi Compressor has a high ratio of current liabilities to total assets of 58%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Key Takeaway
All in all, it's terrific to see that Changhong Huayi Compressor is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a solid 84% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 1 warning sign with Changhong Huayi Compressor and understanding it should be part of your investment process.
While Changhong Huayi Compressor 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.