China Chengtong Development Group (HKG:217) Shareholders Will Want The ROCE Trajectory To Continue

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at China Chengtong Development Group (HKG:217) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on China Chengtong Development Group is:

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

0.021 = HK$119m ÷ (HK$10b - HK$4.4b) (Based on the trailing twelve months to December 2022).

Thus, China Chengtong Development Group has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 4.5%.

See our latest analysis for China Chengtong Development Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Chengtong Development Group's ROCE against it's prior returns. If you're interested in investigating China Chengtong Development Group's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 2.1%. Basically the business is earning more per dollar of capital invested and in addition to that, 84% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 44% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From China Chengtong Development Group's ROCE

In summary, it's great to see that China Chengtong Development Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 57% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

If you'd like to know more about China Chengtong Development Group, we've spotted 5 warning signs, and 2 of them make us uncomfortable.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.