We Like These Underlying Return On Capital Trends At Dongfang Electric (HKG:1072)

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. So when we looked at Dongfang Electric (HKG:1072) and its trend of ROCE, we really liked what we saw.

What is 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 Dongfang Electric is:

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

0.027 = CN¥1.3b ÷ (CN¥104b - CN¥57b) (Based on the trailing twelve months to March 2022).

So, Dongfang Electric has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Electrical industry average of 7.5%.

See our latest analysis for Dongfang Electric

In the above chart we have measured Dongfang Electric'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 Dongfang Electric here for free.

So How Is Dongfang Electric's ROCE Trending?

Dongfang Electric has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 2.7% on its capital. And unsurprisingly, like most companies trying to break into the black, Dongfang Electric is utilizing 82% more capital than it was five years ago. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

On a related note, the company's ratio of current liabilities to total assets has decreased to 55%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see. However, current liabilities are still at a pretty high level, so just be aware that this can bring with it some risks.

What We Can Learn From Dongfang Electric's ROCE

In summary, it's great to see that Dongfang Electric has managed to break into profitability and is continuing to reinvest in its business. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 46% return over the last five years. Therefore, we think it would be worth your time to check if these trends are going to continue.

If you'd like to know more about Dongfang Electric, we've spotted 3 warning signs, and 1 of them makes us a bit uncomfortable.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.