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Returns On Capital Signal Difficult Times Ahead For China Automotive Systems (NASDAQ:CAAS)

·3 min read

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on China Automotive Systems is:

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

0.021 = US$7.3m ÷ (US$694m - US$341m) (Based on the trailing twelve months to June 2022).

Thus, China Automotive Systems has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 10.0%.

View our latest analysis for China Automotive Systems

roce
roce

In the above chart we have measured China Automotive Systems' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From China Automotive Systems' ROCE Trend?

In terms of China Automotive Systems' historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 8.2% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect China Automotive Systems to turn into a multi-bagger.

On a separate but related note, it's important to know that China Automotive Systems has a current liabilities to total assets ratio of 49%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From China Automotive Systems' ROCE

In summary, it's unfortunate that China Automotive Systems is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 28% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we've found 1 warning sign for China Automotive Systems that we think you should be aware of.

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.

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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