Datang Environment Industry Group's (HKG:1272) Returns On Capital Not Reflecting Well On The Business

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Datang Environment Industry Group (HKG:1272) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Datang Environment Industry Group:

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

0.068 = CN¥702m ÷ (CN¥20b - CN¥9.9b) (Based on the trailing twelve months to December 2020).

Therefore, Datang Environment Industry Group has an ROCE of 6.8%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 9.3%.

See our latest analysis for Datang Environment Industry Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Datang Environment Industry Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Datang Environment Industry Group, check out these free graphs here.

What Can We Tell From Datang Environment Industry Group's ROCE Trend?

When we looked at the ROCE trend at Datang Environment Industry Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 6.8% from 15% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

Another thing to note, Datang Environment Industry Group has a high ratio of current liabilities to total assets of 49%. 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 On Datang Environment Industry Group's ROCE

To conclude, we've found that Datang Environment Industry Group is reinvesting in the business, but returns have been falling. And in the last three years, the stock has given away 56% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Datang Environment Industry Group (including 2 which are concerning) .

While Datang Environment Industry Group 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. 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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