Towngas China (HKG:1083) Is Doing The Right Things To Multiply Its Share Price

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Towngas China's (HKG:1083) returns on capital, so let's have a look.

Understanding 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 Towngas China, this is the formula:

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

0.068 = HK$2.1b ÷ (HK$49b - HK$18b) (Based on the trailing twelve months to June 2021).

Therefore, Towngas China has an ROCE of 6.8%. In absolute terms, that's a low return and it also under-performs the Gas Utilities industry average of 8.9%.

View our latest analysis for Towngas China

Above you can see how the current ROCE for Towngas China compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Towngas China here for free.

So How Is Towngas China's ROCE Trending?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The data shows that returns on capital have increased substantially over the last five years to 6.8%. The amount of capital employed has increased too, by 43%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 38% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Key Takeaway

To sum it up, Towngas China has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 20% to shareholders. So with that in mind, we think the stock deserves further research.

On a final note, we found 2 warning signs for Towngas China (1 is potentially serious) you should be aware of.

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.

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.

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