Shanghai Electric Group (HKG:2727) Will Be Looking To Turn Around Its Returns

What financial metrics can indicate to us that a company is maturing or even 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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Shanghai Electric Group (HKG:2727), we weren't too hopeful.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Shanghai Electric Group, this is the formula:

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

0.015 = CN¥1.8b ÷ (CN¥279b - CN¥161b) (Based on the trailing twelve months to March 2024).

Thus, Shanghai Electric Group has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 7.0%.

See our latest analysis for Shanghai Electric Group

In the above chart we have measured Shanghai Electric 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 Shanghai Electric Group for free.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Shanghai Electric Group. Unfortunately the returns on capital have diminished from the 5.1% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Shanghai Electric Group becoming one if things continue as they have.

On a side note, Shanghai Electric Group's current liabilities are still rather high at 58% of total assets. 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.

What We Can Learn From Shanghai Electric Group's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 39% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Shanghai Electric Group could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation for 2727 on our platform quite valuable.

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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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.