What Can The Trends At China Oriental Group (HKG:581) Tell Us About Their Returns?

What are the early trends we should look for to identify a stock that could 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. So when we looked at China Oriental Group (HKG:581) and its trend of ROCE, we really liked what we saw.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for China Oriental Group, this is the formula:

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

0.096 = CN¥2.3b ÷ (CN¥43b - CN¥20b) (Based on the trailing twelve months to June 2020).

Therefore, China Oriental Group has an ROCE of 9.6%. In absolute terms, that's a low return, but it's much better than the Metals and Mining industry average of 7.5%.

See our latest analysis for China Oriental Group

In the above chart we have measured China Oriental Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. Over the last five years, returns on capital employed have risen substantially to 9.6%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 113%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a separate but related note, it's important to know that China Oriental Group has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

To sum it up, China Oriental Group has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And since the stock has fallen 38% over the last three years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

If you want to know some of the risks facing China Oriental Group we've found 4 warning signs (2 are potentially serious!) that you should be aware of before investing here.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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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