Investors Will Want China Chengtong Development Group's (HKG:217) Growth In ROCE To Persist

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Speaking of which, we noticed some great changes in China Chengtong Development Group's (HKG:217) returns on capital, so let's have a look.

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 China Chengtong Development Group, this is the formula:

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

0.026 = HK$121m ÷ (HK$8.1b - HK$3.4b) (Based on the trailing twelve months to June 2022).

So, China Chengtong Development Group has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 5.5%.

View our latest analysis for China Chengtong Development Group

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 Chengtong Development Group, check out these free graphs here.

What Does the ROCE Trend For China Chengtong Development Group Tell Us?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased substantially over the last five years to 2.6%. Basically the business is earning more per dollar of capital invested and in addition to that, 61% 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.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 42% of the business, which is more than it was five years ago. 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.

The Bottom Line

All in all, it's terrific to see that China Chengtong Development Group is reaping the rewards from prior investments and is growing its capital base. Although the company may be facing some issues elsewhere since the stock has plunged 75% in the last five years. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 6 warning signs for China Chengtong Development Group (of which 2 are a bit unpleasant!) that you should know about.

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.