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'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 Hongli Zhihui GroupLtd (SZSE:300219) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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 Hongli Zhihui GroupLtd, this is the formula:

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

0.043 = CN¥136m ÷ (CN¥5.5b - CN¥2.3b) (Based on the trailing twelve months to June 2024).

Thus, Hongli Zhihui GroupLtd has an ROCE of 4.3%. Even though it's in line with the industry average of 4.3%, it's still a low return by itself.

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 , check out these free graphs detailing revenue and cash flow performance of Hongli Zhihui GroupLtd.

What Does the ROCE Trend For Hongli Zhihui GroupLtd Tell Us?

On the surface, the trend of ROCE at Hongli Zhihui GroupLtd doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 4.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that Hongli Zhihui GroupLtd has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Hongli Zhihui GroupLtd's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Hongli Zhihui GroupLtd is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 29% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you want to continue researching Hongli Zhihui GroupLtd, you might be interested to know about the 3 warning signs that our analysis has discovered.

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.