Returns On Capital At Henan Jinma Energy (HKG:6885) Paint A Concerning Picture

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Henan Jinma Energy (HKG:6885) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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 Henan Jinma Energy, this is the formula:

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

0.11 = CN¥721m ÷ (CN¥11b - CN¥4.5b) (Based on the trailing twelve months to December 2022).

Therefore, Henan Jinma Energy has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 8.3% it's much better.

See our latest analysis for Henan Jinma Energy

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Henan Jinma Energy's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Henan Jinma Energy, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 39% five years ago. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Henan Jinma Energy's current liabilities have increased over the last five years to 40% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 11%. 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.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Henan Jinma Energy. These growth trends haven't led to growth returns though, since the stock has fallen 35% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Henan Jinma Energy (of which 2 don't sit too well with us!) that you should know about.

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. 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.