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'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at Wanxiang QianchaoLtd (SZSE:000559), it didn't seem to tick all of these boxes.
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. The formula for this calculation on Wanxiang QianchaoLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = CN¥645m ÷ (CN¥20b - CN¥9.9b) (Based on the trailing twelve months to September 2023).
Therefore, Wanxiang QianchaoLtd has an ROCE of 6.7%. In absolute terms, that's a low return but it's around the Auto Components industry average of 5.8%.
View our latest analysis for Wanxiang QianchaoLtd
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 want to delve into the historical earnings, revenue and cash flow of Wanxiang QianchaoLtd, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
In terms of Wanxiang QianchaoLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.7% from 12% five years ago. However it looks like Wanxiang QianchaoLtd might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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, Wanxiang QianchaoLtd's current liabilities are still rather high at 51% 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.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Wanxiang QianchaoLtd's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 8.7% 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 2 warning signs we've spotted with Wanxiang QianchaoLtd (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.
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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.
