China Energy Engineering (HKG:3996) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think China Energy Engineering (HKG:3996) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for China Energy Engineering:

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

0.049 = CN¥19b ÷ (CN¥815b - CN¥428b) (Based on the trailing twelve months to March 2024).

Thus, China Energy Engineering has an ROCE of 4.9%. Ultimately, that's a low return and it under-performs the Construction industry average of 7.3%.

Check out our latest analysis for China Energy Engineering

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're interested, you can view the analysts predictions in our free analyst report for China Energy Engineering .

What Can We Tell From China Energy Engineering's ROCE Trend?

When we looked at the ROCE trend at China Energy Engineering, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.9% from 6.5% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a separate but related note, it's important to know that China Energy Engineering has a current liabilities to total assets ratio of 52%, which we'd consider pretty high. 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.

The Bottom Line

In summary, China Energy Engineering is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly, the stock has only gained 10% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

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.

While China Energy Engineering 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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com