Zhonghua Gas Holdings (HKG:8246) Knows How To Allocate Capital Effectively

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, the ROCE of Zhonghua Gas Holdings (HKG:8246) looks great, so lets see what the trend can tell us.

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. The formula for this calculation on Zhonghua Gas Holdings is:

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

0.37 = CN¥69m ÷ (CN¥395m - CN¥210m) (Based on the trailing twelve months to June 2023).

Therefore, Zhonghua Gas Holdings has an ROCE of 37%. In absolute terms that's a great return and it's even better than the Construction industry average of 6.5%.

View our latest analysis for Zhonghua Gas Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Zhonghua Gas Holdings, check out these free graphs here.

How Are Returns Trending?

You'd find it hard not to be impressed with the ROCE trend at Zhonghua Gas Holdings. The figures show that over the last five years, returns on capital have grown by 20%. The company is now earning CN¥0.4 per dollar of capital employed. Speaking of capital employed, the company is actually utilizing 46% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 53% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

What We Can Learn From Zhonghua Gas Holdings' ROCE

In the end, Zhonghua Gas Holdings has proven it's capital allocation skills are good with those higher returns from less amount of capital. Although the company may be facing some issues elsewhere since the stock has plunged 77% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.

On a final note, we've found 2 warning signs for Zhonghua Gas Holdings that we think you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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

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.