When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing 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 glancing at the trends within Huadian Power International (HKG:1071), we weren't too hopeful.

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. To calculate this metric for Huadian Power International, this is the formula:

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

0.04 = CN¥6.3b ÷ (CN¥221b - CN¥65b) (Based on the trailing twelve months to March 2024).

Therefore, Huadian Power International has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 7.0%.

Above you can see how the current ROCE for Huadian Power International compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Huadian Power International .

So How Is Huadian Power International's ROCE Trending?

In terms of Huadian Power International's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 5.8% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Huadian Power International becoming one if things continue as they have.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 107%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Huadian Power International (of which 1 is a bit concerning!) that you should know about.

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

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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.