What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Hang Xiao Steel StructureLtd (SHSE:600477) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
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 Hang Xiao Steel StructureLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = CN¥499m ÷ (CN¥16b - CN¥8.5b) (Based on the trailing twelve months to September 2023).
Therefore, Hang Xiao Steel StructureLtd has an ROCE of 7.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.8%.
In the above chart we have measured Hang Xiao Steel StructureLtd'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 Hang Xiao Steel StructureLtd.
What Can We Tell From Hang Xiao Steel StructureLtd's ROCE Trend?
In terms of Hang Xiao Steel StructureLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.1% from 27% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Another thing to note, Hang Xiao Steel StructureLtd has a high ratio of current liabilities to total assets of 55%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Hang Xiao Steel StructureLtd's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 2.6% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
One final note, you should learn about the 3 warning signs we've spotted with Hang Xiao Steel StructureLtd (including 2 which make us uncomfortable) .
While Hang Xiao Steel StructureLtd 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.