Some Investors May Be Worried About China Energy Engineering's (HKG:3996) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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?

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

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

0.048 = CN¥16b ÷ (CN¥698b - CN¥356b) (Based on the trailing twelve months to March 2023).

Therefore, China Energy Engineering has an ROCE of 4.8%. On its own, that's a low figure but it's around the 6.0% average generated by the Construction industry.

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'd like to see what analysts are forecasting going forward, you should check out our free report for China Energy Engineering.

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

We weren't thrilled with the trend because China Energy Engineering's ROCE has reduced by 31% over the last five years, while the business employed 118% more capital. Usually this isn't ideal, but given China Energy Engineering conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with China Energy Engineering's earnings and if they change as a result from the capital raise. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.

Another thing to note, China Energy Engineering has a high ratio of current liabilities to total assets of 51%. 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 trends are starting to be recognized by investors since the stock has delivered a 11% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for China Energy Engineering (of which 1 is a bit concerning!) that 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. 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.