Some Investors May Be Worried About Zhejiang Tengy Environmental Technology's (HKG:1527) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. 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 briefly looking over the numbers, we don't think Zhejiang Tengy Environmental Technology (HKG:1527) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Zhejiang Tengy Environmental Technology is:

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

0.0051 = CN¥3.9m ÷ (CN¥1.5b - CN¥741m) (Based on the trailing twelve months to December 2020).

So, Zhejiang Tengy Environmental Technology has an ROCE of 0.5%. Ultimately, that's a low return and it under-performs the Machinery industry average of 9.1%.

Check out our latest analysis for Zhejiang Tengy Environmental Technology

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Zhejiang Tengy Environmental Technology's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Zhejiang Tengy Environmental Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 0.5% from 22% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Zhejiang Tengy Environmental Technology has done well to pay down its current liabilities to 49% of total assets. That could partly explain why the ROCE has dropped. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Tengy Environmental Technology have fallen, meanwhile the business is employing more capital than it was five years ago. We expect this has contributed to the stock plummeting 80% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Zhejiang Tengy Environmental Technology (of which 1 is a bit unpleasant!) that you should know about.

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. 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.
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