SINOPEC Engineering (Group) Co Ltd (HKG:2386): A Look At Return On Capital

I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in SINOPEC Engineering (Group) Co Ltd (HKG:2386).

Buying SINOPEC Engineering (Group) makes you a partial owner of the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. Your return is tied to 2386’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. To understand SINOPEC Engineering (Group)’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.

Check out our latest analysis for SINOPEC Engineering (Group)

SINOPEC Engineering (Group)’s Return On Capital Employed

As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if SINOPEC Engineering (Group) is good at growing investor capital. Take a look at the formula box beneath:

ROCE Calculation for 2386

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = CN¥1.9b ÷ (CN¥61.2b – CN¥32.4b) = 6.6%

The calculation above shows that 2386’s earnings were 6.6% of capital employed. Comparing this to a healthy 15% benchmark shows SINOPEC Engineering (Group) is currently unable to return a satisfactory amount to owners for the use of their capital, which isn’t good for investors who have forgone other potentially solid companies.

SEHK:2386 Last Perf October 22nd 18
SEHK:2386 Last Perf October 22nd 18

A deeper look

2386 doesn’t return an attractive amount on capital, but this will only continue if the company is unable to increase earnings or decrease current capital requirements. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Looking three years in the past, it is evident that 2386’s ROCE has deteriorated from 16%, indicating the company’s capital returns have declined. In this time, earnings have fallen from CN¥4.2b to CN¥1.9b and capital employed has increased due to a rise in total assets employed , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.

Next Steps

ROCE for 2386 investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. SINOPEC Engineering (Group)’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.

  1. Future Outlook: What are well-informed industry analysts predicting for 2386’s future growth? Take a look at our free research report of analyst consensus for 2386’s outlook.
  2. Valuation: What is 2386 worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether 2386 is currently undervalued by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.