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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating China Railway Group (SHSE:601390), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on China Railway Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = CN¥47b ÷ (CN¥1.7t - CN¥944b) (Based on the trailing twelve months to September 2023).
Thus, China Railway Group has an ROCE of 5.9%. In absolute terms, that's a low return but it's around the Construction industry average of 7.0%.
SHSE:601390 Return on Capital Employed March 10th 2024
Above you can see how the current ROCE for China Railway Group 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 analyst report for China Railway Group .
The Trend Of ROCE
There are better returns on capital out there than what we're seeing at China Railway Group. Over the past five years, ROCE has remained relatively flat at around 5.9% and the business has deployed 164% more capital into its operations. 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 Railway Group has done well to reduce current liabilities to 54% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk. We'd like to see this trend continue though because as it stands today, thats still a pretty high level.
The Bottom Line
In summary, China Railway Group has simply been reinvesting capital and generating the same low rate of return as before. And with the stock having returned a mere 3.0% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for China Railway Group (of which 1 is significant!) that you should know about.
While China Railway Group 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.
