Capital Allocation Trends At Zhejiang Xinzhonggang Thermal Power (SHSE:605162) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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 Zhejiang Xinzhonggang Thermal Power (SHSE:605162), 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 Zhejiang Xinzhonggang Thermal Power, this is the formula:

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

0.094 = CN¥145m ÷ (CN¥1.6b - CN¥97m) (Based on the trailing twelve months to September 2023).

So, Zhejiang Xinzhonggang Thermal Power has an ROCE of 9.4%. In absolute terms, that's a low return, but it's much better than the Electric Utilities industry average of 6.3%.

Check out our latest analysis for Zhejiang Xinzhonggang Thermal Power

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're interested in investigating Zhejiang Xinzhonggang Thermal Power's past further, check out this free graph covering Zhejiang Xinzhonggang Thermal Power's past earnings, revenue and cash flow.

What Can We Tell From Zhejiang Xinzhonggang Thermal Power's ROCE Trend?

On the surface, the trend of ROCE at Zhejiang Xinzhonggang Thermal Power doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.4% from 35% five years ago. However it looks like Zhejiang Xinzhonggang Thermal Power might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Zhejiang Xinzhonggang Thermal Power has done well to pay down its current liabilities to 6.0% 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.

Our Take On Zhejiang Xinzhonggang Thermal Power's ROCE

Bringing it all together, while we're somewhat encouraged by Zhejiang Xinzhonggang Thermal Power's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 23% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing: We've identified 2 warning signs with Zhejiang Xinzhonggang Thermal Power (at least 1 which can't be ignored) , and understanding them would certainly be useful.

While Zhejiang Xinzhonggang Thermal Power 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.