Be Wary Of SINOPEC Engineering (Group) (HKG:2386) And Its Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, SINOPEC Engineering (Group) (HKG:2386) we aren't filled with optimism, but let's investigate further.

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. Analysts use this formula to calculate it for SINOPEC Engineering (Group):

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

0.071 = CN¥2.2b ÷ (CN¥71b - CN¥41b) (Based on the trailing twelve months to December 2020).

Therefore, SINOPEC Engineering (Group) has an ROCE of 7.1%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 9.4%.

Check out our latest analysis for SINOPEC Engineering (Group)

Above you can see how the current ROCE for SINOPEC Engineering (Group) compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering SINOPEC Engineering (Group) here for free.

How Are Returns Trending?

In terms of SINOPEC Engineering (Group)'s historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on SINOPEC Engineering (Group) becoming one if things continue as they have.

Another thing to note, SINOPEC Engineering (Group) has a high ratio of current liabilities to total assets of 57%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with SINOPEC Engineering (Group) and understanding it should be part of your investment process.

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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