Returns On Capital At China Shenhua Energy (HKG:1088) Have Hit The Brakes

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after investigating China Shenhua Energy (HKG:1088), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 China Shenhua Energy is:

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

0.19 = CN¥102b ÷ (CN¥625b - CN¥98b) (Based on the trailing twelve months to December 2022).

Thus, China Shenhua Energy has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 7.3% generated by the Oil and Gas industry.

Check out our latest analysis for China Shenhua Energy

Above you can see how the current ROCE for China Shenhua Energy 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 Shenhua Energy here for free.

How Are Returns Trending?

Over the past five years, China Shenhua Energy's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect China Shenhua Energy to be a multi-bagger going forward. On top of that you'll notice that China Shenhua Energy has been paying out a large portion (75%) of earnings in the form of dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.

In Conclusion...

In summary, China Shenhua Energy isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Yet to long term shareholders the stock has gifted them an incredible 126% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to know some of the risks facing China Shenhua Energy we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While China Shenhua Energy 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.