Be Wary Of China Southern Power Grid Energy Storage (SHSE:600995) And Its Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at China Southern Power Grid Energy Storage (SHSE:600995) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on China Southern Power Grid Energy Storage is:

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

0.042 = CN¥1.8b ÷ (CN¥46b - CN¥2.2b) (Based on the trailing twelve months to March 2024).

Thus, China Southern Power Grid Energy Storage has an ROCE of 4.2%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 5.2%.

Check out our latest analysis for China Southern Power Grid Energy Storage

In the above chart we have measured China Southern Power Grid Energy Storage'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 Southern Power Grid Energy Storage for free.

The Trend Of ROCE

In terms of China Southern Power Grid Energy Storage's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 14%, but since then they've fallen to 4.2%. 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.

On a side note, China Southern Power Grid Energy Storage has done well to pay down its current liabilities to 4.8% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line On China Southern Power Grid Energy Storage's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for China Southern Power Grid Energy Storage have fallen, meanwhile the business is employing more capital than it was five years ago. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 45% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing: We've identified 2 warning signs with China Southern Power Grid Energy Storage (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

While China Southern Power Grid Energy Storage 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.