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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Towngas Smart Energy (HKG:1083), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Towngas Smart Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = HK$2.0b ÷ (HK$53b - HK$16b) (Based on the trailing twelve months to June 2022).
Therefore, Towngas Smart Energy has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Gas Utilities industry average of 8.8%.
In the above chart we have measured Towngas Smart Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Towngas Smart Energy.
How Are Returns Trending?
There are better returns on capital out there than what we're seeing at Towngas Smart Energy. The company has employed 84% more capital in the last five years, and the returns on that capital have remained stable at 5.4%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
Our Take On Towngas Smart Energy's ROCE
In summary, Towngas Smart Energy has simply been reinvesting capital and generating the same low rate of return as before. Since the stock has declined 36% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Towngas Smart Energy has the makings of a multi-bagger.
One final note, you should learn about the 3 warning signs we've spotted with Towngas Smart Energy (including 1 which doesn't sit too well with us) .
While Towngas Smart Energy may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
Towngas Smart Energy
Towngas Smart Energy Company Limited, an investment holding company, sells and distributes piped gas in the People’s Republic of China.
The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.
|Analysis Area||Score (0-6)|
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