Chongqing Machinery & Electric (HKG:2722) Shareholders Will Want The ROCE Trajectory To Continue

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Chongqing Machinery & Electric (HKG:2722) and its trend of ROCE, we really liked what we saw.

What is 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. Analysts use this formula to calculate it for Chongqing Machinery & Electric:

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

0.011 = CN¥110m ÷ (CN¥17b - CN¥7.1b) (Based on the trailing twelve months to December 2020).

Thus, Chongqing Machinery & Electric has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the Industrials industry average of 3.0%.

See our latest analysis for Chongqing Machinery & Electric

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chongqing Machinery & Electric's ROCE against it's prior returns. If you're interested in investigating Chongqing Machinery & Electric's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Chongqing Machinery & Electric's ROCE Trend?

The fact that Chongqing Machinery & Electric is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 1.1% which is a sight for sore eyes. In addition to that, Chongqing Machinery & Electric is employing 21% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

Another thing to note, Chongqing Machinery & Electric has a high ratio of current liabilities to total assets of 43%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

To the delight of most shareholders, Chongqing Machinery & Electric has now broken into profitability. Given the stock has declined 29% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

If you want to know some of the risks facing Chongqing Machinery & Electric we've found 3 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

While Chongqing Machinery & Electric 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.

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