What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. In light of that, when we looked at Weichai Power (HKG:2338) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for Weichai Power, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = CN¥16b ÷ (CN¥344b - CN¥152b) (Based on the trailing twelve months to September 2024).
Therefore, Weichai Power has an ROCE of 8.3%. In absolute terms, that's a low return but it's around the Machinery industry average of 9.0%.
Check out our latest analysis for Weichai Power
In the above chart we have measured Weichai Power'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 Weichai Power .
How Are Returns Trending?
On the surface, the trend of ROCE at Weichai Power doesn't inspire confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 8.3%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.
On a side note, Weichai Power's current liabilities are still rather high at 44% of total assets. 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
Bringing it all together, while we're somewhat encouraged by Weichai Power's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 2.9% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
On a separate note, we've found 1 warning sign for Weichai Power you'll probably want to know about.
While Weichai Power 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.