If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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.
Understanding 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. 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)
0.05 = CN¥18b ÷ (CN¥763b - CN¥402b) (Based on the trailing twelve months to September 2023).
Therefore, China Energy Engineering has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 8.3%.
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 Can We Tell From China Energy Engineering's ROCE Trend?
There are better returns on capital out there than what we're seeing at China Energy Engineering. The company has consistently earned 5.0% for the last five years, and the capital employed within the business has risen 120% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
On a side note, China Energy Engineering's current liabilities are still rather high at 53% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From China Energy Engineering's ROCE
In summary, China Energy Engineering has simply been reinvesting capital and generating the same low rate of return as before. Since the stock has declined 16% over the last five years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
If you'd like to know more about China Energy Engineering, we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.
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.