What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at China Energy Engineering (HKG:3996) and its ROCE trend, we weren't exactly thrilled.

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 China Energy Engineering, this is the formula:

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

0.055 = CN¥15b ÷ (CN¥589b - CN¥310b) (Based on the trailing twelve months to June 2022).

Thus, China Energy Engineering has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Construction industry average of 6.9%.

Check out our latest analysis for China Energy Engineering

Above you can see how the current ROCE for China Energy Engineering compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Energy Engineering here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at China Energy Engineering, we didn't gain much confidence. Around five years ago the returns on capital were 8.6%, but since then they've fallen to 5.5%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that China Energy Engineering has a current liabilities to total assets ratio of 53%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On China Energy Engineering'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 China Energy Engineering. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One final note, you should learn about the 2 warning signs we've spotted with China Energy Engineering (including 1 which makes us a bit uncomfortable) .

While China Energy Engineering 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.