The Returns On Capital At CGN Mining (HKG:1164) Don't Inspire Confidence

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating CGN Mining (HKG:1164), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on CGN Mining is:

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

0.048 = HK$177m ÷ (HK$7.1b - HK$3.4b) (Based on the trailing twelve months to June 2022).

Thus, CGN Mining has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 12%.

Check out the opportunities and risks within the HK Oil and Gas industry.

In the above chart we have measured CGN Mining'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 CGN Mining.

How Are Returns Trending?

We weren't thrilled with the trend because CGN Mining's ROCE has reduced by 69% over the last five years, while the business employed 112% more capital. Usually this isn't ideal, but given CGN Mining conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence CGN Mining might not have received a full period of earnings contribution from it.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 48%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

Our Take On CGN Mining's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that CGN Mining is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 47% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing to note, we've identified 2 warning signs with CGN Mining and understanding these should be part of your investment process.

While CGN Mining isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.