Capital Allocation Trends At China Automotive Systems (NASDAQ:CAAS) Aren't Ideal
Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, China Automotive Systems (NASDAQ:CAAS) we aren't filled with optimism, but let's investigate further.
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 China Automotive Systems is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0027 = US$972k ÷ (US$686m - US$332m) (Based on the trailing twelve months to September 2021).
So, China Automotive Systems has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 8.4%.
View our latest analysis for China Automotive Systems
Above you can see how the current ROCE for China 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 to see what analysts are forecasting going forward, you should check out our free report for China Automotive Systems.
The Trend Of ROCE
We are a bit worried about the trend of returns on capital at China Automotive Systems. About five years ago, returns on capital were 8.0%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on China Automotive Systems becoming one if things continue as they have.
On a side note, China Automotive Systems' current liabilities are still rather high at 48% 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 Bottom Line On China Automotive Systems' ROCE
In summary, it's unfortunate that China Automotive Systems is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 43% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing to note, we've identified 2 warning signs with China Automotive Systems and understanding these should be part of your investment process.
While China Automotive Systems isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
