Returns On Capital At China Shenhua Energy (HKG:1088) Paint An Interesting Picture

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at China Shenhua Energy (HKG:1088) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for China Shenhua Energy:

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

0.12 = CN¥60b ÷ (CN¥566b - CN¥73b) (Based on the trailing twelve months to September 2020).

Therefore, China Shenhua Energy has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 6.8% generated by the Oil and Gas industry.

See our latest analysis for China Shenhua Energy

In the above chart we have measured China Shenhua Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China Shenhua Energy here for free.

What The Trend Of ROCE Can Tell Us

Things have been pretty stable at China Shenhua Energy, with its capital employed and returns on that capital staying somewhat the same for the last five years. 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. So don't be surprised if China Shenhua Energy doesn't end up being a multi-bagger in a few years time. This probably explains why China Shenhua Energy is paying out 50% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.

The Bottom Line

In a nutshell, China Shenhua Energy has been trudging along with the same returns from the same amount of capital over the last five years. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 101% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

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

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. 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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