Returns On Capital Signal Tricky Times Ahead For Hunan Heshun PetroleumLtd (SHSE:603353)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Hunan Heshun PetroleumLtd (SHSE:603353), it didn't seem to tick all of these boxes.

What Is 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. Analysts use this formula to calculate it for Hunan Heshun PetroleumLtd:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.043 = CN¥84m ÷ (CN¥2.2b - CN¥299m) (Based on the trailing twelve months to September 2023).

So, Hunan Heshun PetroleumLtd has an ROCE of 4.3%. Even though it's in line with the industry average of 4.3%, it's still a low return by itself.

View our latest analysis for Hunan Heshun PetroleumLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hunan Heshun PetroleumLtd.

So How Is Hunan Heshun PetroleumLtd's ROCE Trending?

In terms of Hunan Heshun PetroleumLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 45%, but since then they've fallen to 4.3%. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

On a side note, Hunan Heshun PetroleumLtd has done well to pay down its current liabilities to 13% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Hunan Heshun PetroleumLtd's ROCE

We're a bit apprehensive about Hunan Heshun PetroleumLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 53% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Hunan Heshun PetroleumLtd (of which 1 can't be ignored!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.