China Water Industry Group (HKG:1129) Could Be Struggling To Allocate Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, China Water Industry Group (HKG:1129) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for China Water Industry Group, this is the formula:

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

0.013 = HK$29m ÷ (HK$3.3b - HK$966m) (Based on the trailing twelve months to June 2023).

Thus, China Water Industry Group has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Water Utilities industry average of 6.0%.

See our latest analysis for China Water Industry Group

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 China Water Industry Group's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is China Water Industry Group's ROCE Trending?

In terms of China Water Industry Group's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 6.8%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect China Water Industry Group to turn into a multi-bagger.

The Bottom Line On China Water Industry Group's ROCE

In summary, it's unfortunate that China Water Industry Group is generating lower returns from the same amount of capital. Unsurprisingly then, the stock has dived 90% over the last five years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

China Water Industry Group does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...

While China Water Industry Group 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. 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.