China Nature Energy Technology Holdings (HKG:1597) Will Be Hoping To Turn Its Returns On Capital Around

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at China Nature Energy Technology Holdings (HKG:1597) and its ROCE trend, we weren't exactly thrilled.

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 China Nature Energy Technology Holdings is:

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

0.11 = CN¥30m ÷ (CN¥504m - CN¥238m) (Based on the trailing twelve months to December 2021).

So, China Nature Energy Technology Holdings has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Electrical industry average of 8.2% it's much better.

Check out our latest analysis for China Nature Energy Technology Holdings

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 China Nature Energy Technology Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From China Nature Energy Technology Holdings' ROCE Trend?

On the surface, the trend of ROCE at China Nature Energy Technology Holdings doesn't inspire confidence. Over the last four years, returns on capital have decreased to 11% from 16% four years ago. However it looks like China Nature Energy Technology Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

Another thing to note, China Nature Energy Technology Holdings has a high ratio of current liabilities to total assets of 47%. 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

Bringing it all together, while we're somewhat encouraged by China Nature Energy Technology Holdings' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 75% over the last year, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know about the risks facing China Nature Energy Technology Holdings, we've discovered 2 warning signs that you should be aware of.

While China Nature Energy Technology Holdings isn't earning the highest return, check out this free list of companies that are 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.