What trends should we look for it we want to identify stocks that can 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at HUAYU Automotive Systems (SHSE:600741) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on HUAYU Automotive Systems is:

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

0.074 = CN¥5.4b ÷ (CN¥175b - CN¥102b) (Based on the trailing twelve months to March 2024).

Thus, HUAYU Automotive Systems has an ROCE of 7.4%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.9%.

Above you can see how the current ROCE for HUAYU Automotive Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering HUAYU Automotive Systems for free.

What Does the ROCE Trend For HUAYU Automotive Systems Tell Us?

Things have been pretty stable at HUAYU Automotive Systems, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect HUAYU Automotive Systems to be a multi-bagger going forward. This probably explains why HUAYU Automotive Systems is paying out 45% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

On a separate but related note, it's important to know that HUAYU Automotive Systems has a current liabilities to total assets ratio of 58%, which we'd consider pretty high. 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.

In Conclusion...

We can conclude that in regards to HUAYU Automotive Systems' returns on capital employed and the trends, there isn't much change to report on. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing, we've spotted 1 warning sign facing HUAYU Automotive Systems that you might find interesting.

While HUAYU Automotive Systems 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com