Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within Datang International Power Generation (HKG:991), we weren't too hopeful.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Datang International Power Generation is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.029 = CN¥6.5b ÷ (CN¥301b - CN¥78b) (Based on the trailing twelve months to September 2023).
Therefore, Datang International Power Generation has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 6.1%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Datang International Power Generation's ROCE against it's prior returns. If you're interested in investigating Datang International Power Generation's past further, check out this free graph covering Datang International Power Generation's past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Datang International Power Generation, given the returns are trending downwards. To be more specific, the ROCE was 4.9% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Datang International Power Generation becoming one if things continue as they have.
What We Can Learn From Datang International Power Generation's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 16% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing to note, we've identified 2 warning signs with Datang International Power Generation and understanding these should be part of your investment process.
While Datang International Power Generation 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.