Some Investors May Be Worried About Huadi International Group's (NASDAQ:HUDI) Returns On Capital
To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Huadi International Group (NASDAQ:HUDI) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is 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. 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).
Thus, 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 20%.
See our latest analysis for Huadi International Group
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're interested in investigating Huadi International Group's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Huadi International Group Tell Us?
On the surface, the trend of ROCE at Huadi International Group doesn't inspire confidence. Over the last four years, returns on capital have decreased to 5.0% from 42% four years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
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. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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. Keep in mind 49% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line
While returns have fallen for Huadi International Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 286% return over the last year, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
If you want to know some of the risks facing Huadi International Group we've found 3 warning signs (2 are a bit concerning!) that you should be aware of before investing here.
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.
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.
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