Returns On Capital Are Showing Encouraging Signs At China Chengtong Development Group (HKG:217)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. 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)

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)

0.025 = HK$76m ÷ (HK$3.9b - HK$872m) (Based on the trailing twelve months to December 2020).

Thus, China Chengtong Development Group has an ROCE of 2.5%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 3.5%.

View 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.

So How Is China Chengtong Development Group's ROCE Trending?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The figures show that over the last five years, ROCE has grown 3,947% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 22% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line

In summary, we're delighted to see that China Chengtong Development Group has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Although the company may be facing some issues elsewhere since the stock has plunged 76% in the last five years. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

China Chengtong Development Group does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) we think 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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