Some Investors May Be Worried About China Nature Energy Technology Holdings' (HKG:1597) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating China Nature Energy Technology Holdings (HKG:1597), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for China Nature Energy Technology Holdings, this is the formula:

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

0.045 = CN¥12m ÷ (CN¥442m - CN¥169m) (Based on the trailing twelve months to December 2022).

Therefore, China Nature Energy Technology Holdings has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Electrical industry average of 6.0%.

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 want to delve into the historical earnings, revenue and cash flow of China Nature Energy Technology Holdings, check out these free graphs here.

So How Is China Nature Energy Technology Holdings' ROCE Trending?

When we looked at the ROCE trend at China Nature Energy Technology Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.5% from 16% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, China Nature Energy Technology Holdings has decreased its current liabilities to 38% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On China Nature Energy Technology Holdings' ROCE

In summary, we're somewhat concerned by China Nature Energy Technology Holdings' diminishing returns on increasing amounts of capital. However the stock has delivered a 90% return to shareholders over the last year, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing: We've identified 2 warning signs with China Nature Energy Technology Holdings (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

While China Nature Energy Technology Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.