What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. So when we looked at AVIC Heavy Machinery (SHSE:600765) and its trend of ROCE, we really liked what we saw.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for AVIC Heavy Machinery, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = CN¥1.8b ÷ (CN¥25b - CN¥11b) (Based on the trailing twelve months to September 2023).
Thus, AVIC Heavy Machinery has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 6.1% it's much better.
See our latest analysis for AVIC Heavy Machinery
In the above chart we have measured AVIC Heavy Machinery's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for AVIC Heavy Machinery.
What The Trend Of ROCE Can Tell Us
We like the trends that we're seeing from AVIC Heavy Machinery. Over the last five years, returns on capital employed have risen substantially to 13%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 126%. 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, AVIC Heavy Machinery has a high ratio of current liabilities to total assets of 43%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Key Takeaway
To sum it up, AVIC Heavy Machinery has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 161% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.
If you want to continue researching AVIC Heavy Machinery, you might be interested to know about the 1 warning sign that our analysis has discovered.
While AVIC Heavy Machinery 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.