If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Although, when we looked at Shanghai Electric Group (HKG:2727), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Shanghai Electric Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0088 = CN¥1.0b ÷ (CN¥287b - CN¥168b) (Based on the trailing twelve months to September 2023).
So, Shanghai Electric Group has an ROCE of 0.9%. Ultimately, that's a low return and it under-performs the Electrical industry average of 5.7%.
See our latest analysis for Shanghai Electric Group
In the above chart we have measured Shanghai Electric Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanghai Electric Group here for free.
What Does the ROCE Trend For Shanghai Electric Group Tell Us?
When we looked at the ROCE trend at Shanghai Electric Group, we didn't gain much confidence. Around five years ago the returns on capital were 3.2%, but since then they've fallen to 0.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Shanghai Electric Group's current liabilities are still rather high at 59% of total assets. 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 Shanghai Electric Group's ROCE
Bringing it all together, while we're somewhat encouraged by Shanghai Electric Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 33% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Shanghai Electric Group has the makings of a multi-bagger.
While Shanghai Electric Group doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
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.
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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.