Should You Be Impressed By China Energy Engineering's (HKG:3996) Returns on Capital?

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at China Energy Engineering (HKG:3996) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. The formula for this calculation on China Energy Engineering is:

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

0.05 = CN¥10b ÷ (CN¥448b - CN¥239b) (Based on the trailing twelve months to September 2020).

Therefore, China Energy Engineering has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Construction industry average of 10%.

View our latest analysis for China Energy Engineering

Above you can see how the current ROCE for China Energy Engineering compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Energy Engineering here for free.

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

On the surface, the trend of ROCE at China Energy Engineering doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.0% from 8.1% five years ago. 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.

On a separate but related note, it's important to know that China Energy Engineering has a current liabilities to total assets ratio of 53%, which we'd consider pretty high. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

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. These growth trends haven't led to growth returns though, since the stock has fallen 27% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

China Energy Engineering does have some risks, we noticed 3 warning signs (and 1 which is concerning) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. 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.
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