Here's What's Concerning About SINOPEC Engineering (Group)'s (HKG:2386) Returns On Capital

When researching a stock for investment, what can tell us that the company is in decline? 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.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on SINOPEC Engineering (Group) is:

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

0.074 = CN¥2.3b ÷ (CN¥72b - CN¥41b) (Based on the trailing twelve months to June 2021).

Therefore, SINOPEC Engineering (Group) has an ROCE of 7.4%. In absolute terms, that's a low return but it's around the Construction industry average of 8.1%.

View our latest analysis for SINOPEC Engineering (Group)

In the above chart we have measured SINOPEC Engineering (Group)'s prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering SINOPEC Engineering (Group) here for free.

So How Is SINOPEC Engineering (Group)'s ROCE Trending?

We are a bit worried about the trend of returns on capital at SINOPEC Engineering (Group). To be more specific, the ROCE was 9.4% five years ago, but since then it has dropped noticeably. 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. If these trends continue, we wouldn't expect SINOPEC Engineering (Group) to turn into a multi-bagger.

On a side note, SINOPEC Engineering (Group)'s current liabilities are still rather high at 57% of total assets. 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...

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. It should come as no surprise then that the stock has fallen 21% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a separate note, we've found 1 warning sign for SINOPEC Engineering (Group) you'll probably want to know about.

While SINOPEC Engineering (Group) 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.

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.

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