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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at CGN Power (HKG:1816) so let's look a bit deeper.
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. To calculate this metric for CGN Power, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.074 = CN¥25b ÷ (CN¥414b - CN¥75b) (Based on the trailing twelve months to September 2023).
So, CGN Power has an ROCE of 7.4%. In absolute terms, that's a low return but it's around the Renewable Energy industry average of 6.3%.
In the above chart we have measured CGN Power's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From CGN Power's ROCE Trend?
CGN Power has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 42% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
What We Can Learn From CGN Power's ROCE
In summary, we're delighted to see that CGN Power has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Considering the stock has delivered 35% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
On a final note, we found 2 warning signs for CGN Power (1 shouldn't be ignored) you should be aware of.
While CGN Power 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.