If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Zhejiang Changhua Auto Parts (SHSE:605018), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Zhejiang Changhua Auto Parts is:

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

0.021 = CN¥56m ÷ (CN¥3.3b - CN¥610m) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Changhua Auto Parts has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 5.8%.

See our latest analysis for Zhejiang Changhua Auto Parts

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'd like to look at how Zhejiang Changhua Auto Parts has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Zhejiang Changhua Auto Parts' ROCE Trending?

On the surface, the trend of ROCE at Zhejiang Changhua Auto Parts doesn't inspire confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 2.1%. 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 related note, Zhejiang Changhua Auto Parts has decreased its current liabilities to 18% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Zhejiang Changhua Auto Parts. These growth trends haven't led to growth returns though, since the stock has fallen 46% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know more about Zhejiang Changhua Auto Parts, we've spotted 2 warning signs, and 1 of them can't be ignored.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.