Returns On Capital At Henan Zhongyuan Expressway (SHSE:600020) Paint A Concerning Picture

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. In light of that, when we looked at Henan Zhongyuan Expressway (SHSE:600020) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Henan Zhongyuan Expressway, this is the formula:

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

0.043 = CN¥1.9b ÷ (CN¥50b - CN¥5.6b) (Based on the trailing twelve months to June 2024).

So, Henan Zhongyuan Expressway has an ROCE of 4.3%. In absolute terms, that's a low return but it's around the Infrastructure industry average of 5.1%.

Check out our latest analysis for Henan Zhongyuan Expressway

Historical performance is a great place to start when researching a stock so above you can see the gauge for Henan Zhongyuan Expressway's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Henan Zhongyuan Expressway.

The Trend Of ROCE

On the surface, the trend of ROCE at Henan Zhongyuan Expressway doesn't inspire confidence. Around five years ago the returns on capital were 8.6%, but since then they've fallen to 4.3%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Henan Zhongyuan Expressway has decreased its current liabilities to 11% of total assets. So we could link some of this to the decrease in ROCE. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Henan Zhongyuan Expressway's ROCE

Bringing it all together, while we're somewhat encouraged by Henan Zhongyuan Expressway's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 2.8% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

One more thing: We've identified 3 warning signs with Henan Zhongyuan Expressway (at least 2 which make us uncomfortable) , and understanding these would certainly be useful.

While Henan Zhongyuan Expressway 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.