Perennial Energy Holdings (HKG:2798) Could Be Struggling To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Looking at Perennial Energy Holdings (HKG:2798), it does have a high ROCE right now, but lets see how returns are trending.

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. Analysts use this formula to calculate it for Perennial Energy Holdings:

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

0.35 = CN¥932m ÷ (CN¥4.1b - CN¥1.5b) (Based on the trailing twelve months to December 2022).

Therefore, Perennial Energy Holdings has an ROCE of 35%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 8.3%.

View our latest analysis for Perennial Energy Holdings

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Perennial Energy Holdings, we didn't gain much confidence. Historically returns on capital were even higher at 54%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Perennial Energy Holdings has decreased its current liabilities to 36% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Perennial Energy Holdings' ROCE

While returns have fallen for Perennial Energy Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 68% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you'd like to know more about Perennial Energy Holdings, we've spotted 2 warning signs, and 1 of them is significant.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.