Huadian Power International (HKG:1071) Is Finding It Tricky To Allocate Its Capital

What financial metrics can indicate to us that a company is maturing or even in decline? 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 indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Huadian Power International (HKG:1071), so let's see why.

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 Huadian Power International:

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

0.04 = CN¥6.4b ÷ (CN¥222b - CN¥63b) (Based on the trailing twelve months to September 2024).

So, Huadian Power International has an ROCE of 4.0%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 6.9%.

Check out our latest analysis for Huadian Power International

Above you can see how the current ROCE for Huadian Power International compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Huadian Power International .

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Huadian Power International, given the returns are trending downwards. To be more specific, the ROCE was 6.2% five years ago, but since then it has dropped noticeably. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Huadian Power International becoming one if things continue as they have.

Our Take On Huadian Power International's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 79% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Huadian Power International (of which 1 is a bit unpleasant!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.