Returns On Capital Are Showing Encouraging Signs At Dongfang Electric (HKG:1072)

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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. With that in mind, we've noticed some promising trends at Dongfang Electric (HKG:1072) so let's look a bit deeper.

Return On Capital Employed (ROCE): What Is It?

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 Dongfang Electric, this is the formula:

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

0.041 = CN¥1.9b ÷ (CN¥114b - CN¥66b) (Based on the trailing twelve months to September 2022).

Therefore, Dongfang Electric has an ROCE of 4.1%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 7.8%.

See our latest analysis for Dongfang Electric

Above you can see how the current ROCE for Dongfang Electric compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Dongfang Electric here for free.

The Trend Of ROCE

We're delighted to see that Dongfang Electric is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 4.1% which is a sight for sore eyes. In addition to that, Dongfang Electric is employing 85% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a side note, Dongfang Electric's current liabilities are still rather high at 58% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Dongfang Electric's ROCE

Overall, Dongfang Electric gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Dongfang Electric can keep these trends up, it could have a bright future ahead.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.