Stock Analysis

Here's What's Concerning About MECOM Power and Construction's (HKG:1183) Returns On Capital

SEHK:1183
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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Looking at MECOM Power and Construction (HKG:1183), it does have a high ROCE right now, but lets see how returns are trending.

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 MECOM Power and Construction, this is the formula:

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

0.20 = MO$95m ÷ (MO$995m - MO$512m) (Based on the trailing twelve months to December 2022).

Therefore, MECOM Power and Construction has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 6.0% earned by companies in a similar industry.

See our latest analysis for MECOM Power and Construction

roce
SEHK:1183 Return on Capital Employed August 8th 2023

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

On the surface, the trend of ROCE at MECOM Power and Construction doesn't inspire confidence. Historically returns on capital were even higher at 49%, 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, MECOM Power and Construction has a high ratio of current liabilities to total assets of 51%. 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.

What We Can Learn From MECOM Power and Construction's ROCE

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 178% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One final note, you should learn about the 2 warning signs we've spotted with MECOM Power and Construction (including 1 which doesn't sit too well with us) .

MECOM Power and Construction is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

Valuation is complex, but we're helping make it simple.

Find out whether MECOM Power and Construction is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.