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China Automotive Systems' (NASDAQ:CAAS) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into China Automotive Systems (NASDAQ:CAAS), the trends above didn't look too great.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for China Automotive Systems:

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

0.034 = US$12m ÷ (US$675m - US$335m) (Based on the trailing twelve months to September 2022).

Thus, China Automotive Systems has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 12%.

Check out our latest analysis for China Automotive Systems

roce
roce

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.

How Are Returns Trending?

In terms of China Automotive Systems' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 7.6% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. 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 separate but related note, it's important to know that China Automotive Systems has a current liabilities to total assets ratio of 50%, which we'd consider pretty high. 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.

Our Take On China Automotive Systems' ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 55% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with China Automotive Systems (including 1 which doesn't sit too well with us) .

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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