Capital Allocation Trends At MECOM Power and Construction (HKG:1183) Aren't Ideal

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So while MECOM Power and Construction (HKG:1183) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. The formula for this calculation on MECOM Power and Construction is:

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

0.29 = MO$135m ÷ (MO$918m - MO$444m) (Based on the trailing twelve months to June 2022).

Thus, MECOM Power and Construction has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Construction industry average of 7.3%.

See our latest analysis for MECOM Power and Construction

Historical performance is a great place to start when researching a stock so above you can see the gauge for MECOM Power and Construction's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of MECOM Power and Construction, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

In terms of MECOM Power and Construction's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 50%, but they have dropped over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that MECOM Power and Construction has a current liabilities to total assets ratio of 48%, which we'd consider pretty high. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for MECOM Power and Construction. And the stock has done incredibly well with a 289% return over the last three years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

MECOM Power and Construction does have some risks though, and we've spotted 1 warning sign for MECOM Power and Construction that you might be interested in.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.