What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, the ROCE of MECOM Power and Construction (HKG:1183) looks decent, right now, so lets see what the trend of returns can tell us.

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

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. The formula for this calculation on MECOM Power and Construction is:

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

0.18 = MO$102m ÷ (MO$1.1b - MO$567m) (Based on the trailing twelve months to June 2023).

Therefore, MECOM Power and Construction has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 8.0% it's much better.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how MECOM Power and Construction has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

While the current returns on capital are decent, they haven't changed much. The company has consistently earned 18% for the last five years, and the capital employed within the business has risen 31% in that time. Since 18% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 50% of total assets, this reported ROCE would probably be less than18% because total capital employed would be higher.The 18% ROCE could be even lower if current liabilities weren't 50% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

In Conclusion...

In the end, MECOM Power and Construction has proven its ability to adequately reinvest capital at good rates of return. Yet over the last five years the stock has declined 34%, so the decline might provide an opening. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.

On a final note, we found 4 warning signs for MECOM Power and Construction (1 shouldn't be ignored) you should be aware of.

While MECOM Power and Construction 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.