Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Towngas Smart Energy (HKG:1083) and its ROCE trend, we weren't exactly thrilled.
Understanding 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 Towngas Smart Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = HK$1.5b ÷ (HK$55b - HK$17b) (Based on the trailing twelve months to June 2023).
So, Towngas Smart Energy has an ROCE of 4.0%. In absolute terms, that's a low return and it also under-performs the Gas Utilities industry average of 8.2%.
Check out our latest analysis for Towngas Smart Energy
Above you can see how the current ROCE for Towngas Smart Energy 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 Towngas Smart Energy.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Towngas Smart Energy doesn't inspire confidence. Around five years ago the returns on capital were 6.4%, but since then they've fallen to 4.0%. However it looks like Towngas Smart Energy might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Key Takeaway
To conclude, we've found that Towngas Smart Energy is reinvesting in the business, but returns have been falling. Since the stock has declined 42% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
One more thing: We've identified 5 warning signs with Towngas Smart Energy (at least 1 which is potentially serious) , and understanding them would certainly be useful.
While Towngas Smart Energy may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.