Be Wary Of China Energy Engineering (HKG:3996) And Its Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating China Energy Engineering (HKG:3996), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for China Energy Engineering, this is the formula:

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

0.055 = CN¥15b ÷ (CN¥589b - CN¥310b) (Based on the trailing twelve months to June 2022).

Thus, China Energy Engineering has an ROCE of 5.5%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 7.0%.

Check out the opportunities and risks within the HK Construction industry.

In the above chart we have measured China Energy Engineering's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Energy Engineering.

What Does the ROCE Trend For China Energy Engineering Tell Us?

On the surface, the trend of ROCE at China Energy Engineering doesn't inspire confidence. To be more specific, ROCE has fallen from 8.6% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, China Energy Engineering has a high ratio of current liabilities to total assets of 53%. 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 China Energy Engineering's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that China Energy Engineering is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 27% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

China Energy Engineering does have some risks though, and we've spotted 1 warning sign for China Energy Engineering that you might be interested in.

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.