Hengsheng Energy (SHSE:605580) Will Want To Turn Around Its Return Trends

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Hengsheng Energy (SHSE:605580), 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. The formula for this calculation on Hengsheng Energy is:

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

0.15 = CN¥156m ÷ (CN¥1.3b - CN¥256m) (Based on the trailing twelve months to September 2023).

Thus, Hengsheng Energy has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Integrated Utilities industry average of 4.5% it's much better.

Check out our latest analysis for Hengsheng Energy

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 Hengsheng Energy.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Hengsheng Energy doesn't inspire confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 15%. However it looks like Hengsheng Energy 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, Hengsheng Energy has done well to pay down its current liabilities to 20% 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. 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 Hengsheng Energy's ROCE

In summary, Hengsheng Energy is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 12% in the last year. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a final note, we found 2 warning signs for Hengsheng Energy (1 shouldn't be ignored) you should be aware of.

While Hengsheng Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.