Capital Allocation Trends At Tianneng Power International (HKG:819) Aren't Ideal

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Tianneng Power International (HKG:819), we don't think it's current trends fit the mold of a multi-bagger.

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 Tianneng Power International is:

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

0.027 = CN¥695m ÷ (CN¥54b - CN¥28b) (Based on the trailing twelve months to June 2024).

So, Tianneng Power International has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 6.5%.

See our latest analysis for Tianneng Power International

In the above chart we have measured Tianneng Power International'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 Tianneng Power International for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Tianneng Power International doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.7% from 22% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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, Tianneng Power International has decreased its current liabilities to 52% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Tianneng Power International's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 70% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Tianneng Power International does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

While Tianneng Power International 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.