If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into PetroChina (HKG:857), the trends above didn't look too great.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for PetroChina:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.025 = CN¥47b ÷ (CN¥2.6t - CN¥682b) (Based on the trailing twelve months to September 2020).
So, PetroChina has an ROCE of 2.5%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 6.8%.
In the above chart we have measured PetroChina'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 PetroChina.
What Can We Tell From PetroChina's ROCE Trend?
We are a bit worried about the trend of returns on capital at PetroChina. Unfortunately the returns on capital have diminished from the 4.9% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect PetroChina to turn into a multi-bagger.
Our Take On PetroChina's ROCE
In summary, it's unfortunate that PetroChina is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 44% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a final note, we've found 2 warning signs for PetroChina that we think you should be aware of.
While PetroChina 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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