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Huadi International Group (NASDAQ:HUDI) Could Be Struggling To Allocate Capital

·3 min read

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Huadi International Group (NASDAQ:HUDI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

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 Huadi International Group, this is the formula:

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

0.05 = US$2.6m ÷ (US$100m - US$49m) (Based on the trailing twelve months to September 2021).

So, Huadi International Group has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 17%.

See our latest analysis for Huadi International Group

roce
roce

Historical performance is a great place to start when researching a stock so above you can see the gauge for Huadi International Group's ROCE against it's prior returns. If you'd like to look at how Huadi International Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Huadi International Group's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 42%, but since then they've fallen to 5.0%. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Huadi International Group has decreased its current liabilities to 49% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line On Huadi International Group's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Huadi International Group. And the stock has done incredibly well with a 214% return over the last year, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One final note, you should learn about the 4 warning signs we've spotted with Huadi International Group (including 2 which are a bit unpleasant) .

While Huadi International Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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

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.