What trends should we look for it we want to identify stocks that can 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. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. Although, when we looked at China Petroleum & Chemical (HKG:386), it didn’t seem to tick all of these boxes.
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 Petroleum & Chemical, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.013 = CN¥16b ÷ (CN¥1.8t – CN¥629b) (Based on the trailing twelve months to June 2020).
Therefore, China Petroleum & Chemical has an ROCE of 1.3%. In absolute terms, that’s a low return and it also under-performs the Oil and Gas industry average of 6.8%.
In the above chart we have measured China Petroleum & Chemical’s prior ROCE against its prior performance, but the future is arguably more important. If you’d like, you can check out the forecasts from the analysts covering China Petroleum & Chemical here for free.
What Can We Tell From China Petroleum & Chemical’s ROCE Trend?
In terms of China Petroleum & Chemical’s historical ROCE movements, the trend isn’t fantastic. Over the last five years, returns on capital have decreased to 1.3% from 6.7% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven’t increased.
In summary, we’re somewhat concerned by China Petroleum & Chemical’s diminishing returns on increasing amounts of capital. Long term shareholders who’ve owned the stock over the last five years have experienced a 11% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren’t great in these areas, we’d consider looking elsewhere.
If you want to continue researching China Petroleum & Chemical, you might be interested to know about the 2 warning signs that our analysis has discovered.
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This article by Simply Wall St is general in nature. 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.
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