Chengdu Expressway's (HKG:1785) Returns On Capital Not Reflecting Well On The Business

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Chengdu Expressway (HKG:1785), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Chengdu Expressway:

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

0.062 = CN¥468m ÷ (CN¥9.1b - CN¥1.5b) (Based on the trailing twelve months to December 2020).

So, Chengdu Expressway has an ROCE of 6.2%. Even though it's in line with the industry average of 6.3%, it's still a low return by itself.

See our latest analysis for Chengdu Expressway

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Chengdu Expressway, we didn't gain much confidence. Around five years ago the returns on capital were 9.5%, but since then they've fallen to 6.2%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Chengdu Expressway. And the stock has followed suit returning a meaningful 8.9% to shareholders over the last year. 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.

Chengdu Expressway does have some risks, we noticed 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.

While Chengdu Expressway 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. 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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