Here's What's Concerning About Hongli Group's (NASDAQ:HLP) Returns On Capital
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Hongli Group (NASDAQ:HLP) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Hongli Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.092 = US$2.2m ÷ (US$31m - US$7.3m) (Based on the trailing twelve months to June 2023).
Thus, Hongli Group has an ROCE of 9.2%. On its own, that's a low figure but it's around the 11% average generated by the Metals and Mining industry.
See our latest analysis for Hongli Group
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hongli Group's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hongli Group.
The Trend Of ROCE
When we looked at the ROCE trend at Hongli Group, we didn't gain much confidence. Around three years ago the returns on capital were 40%, but since then they've fallen to 9.2%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a side note, Hongli Group has done well to pay down its current liabilities to 23% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
From the above analysis, we find it rather worrisome that returns on capital and sales for Hongli Group have fallen, meanwhile the business is employing more capital than it was three years ago. It should come as no surprise then that the stock has fallen 68% over the last year, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you'd like to know more about Hongli Group, we've spotted 4 warning signs, and 2 of them are potentially serious.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
