What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at AVIC Heavy Machinery (SHSE:600765) so let's look a bit deeper.
Understanding 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. The formula for this calculation on AVIC Heavy Machinery is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = CN¥1.6b ÷ (CN¥25b - CN¥11b) (Based on the trailing twelve months to December 2023).
So, AVIC Heavy Machinery has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 6.3% it's much better.
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're interested, you can view the analysts predictions in our free analyst report for AVIC Heavy Machinery .
So How Is AVIC Heavy Machinery's ROCE Trending?
The trends we've noticed at AVIC Heavy Machinery are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 11%. Basically the business is earning more per dollar of capital invested and in addition to that, 123% more capital is being employed now too. 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.
On a side note, AVIC Heavy Machinery's current liabilities are still rather high at 42% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From AVIC Heavy Machinery's ROCE
All in all, it's terrific to see that AVIC Heavy Machinery is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a staggering 157% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if AVIC Heavy Machinery can keep these trends up, it could have a bright future ahead.
One final note, you should learn about the 2 warning signs we've spotted with AVIC Heavy Machinery (including 1 which is a bit unpleasant) .
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.