China Everbright Greentech (HKG:1257) Is Reinvesting At Lower Rates Of Return

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at China Everbright Greentech (HKG:1257) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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. Analysts use this formula to calculate it for China Everbright Greentech:

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

0.052 = HK$1.6b ÷ (HK$41b - HK$9.5b) (Based on the trailing twelve months to June 2022).

Thus, China Everbright Greentech has an ROCE of 5.2%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 6.6%.

Our analysis indicates that 1257 is potentially undervalued!

In the above chart we have measured China Everbright Greentech's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is China Everbright Greentech's ROCE Trending?

When we looked at the ROCE trend at China Everbright Greentech, we didn't gain much confidence. To be more specific, ROCE has fallen from 10% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, China Everbright Greentech's current liabilities have increased over the last five years to 23% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On China Everbright Greentech's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for China Everbright Greentech have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 69% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to know some of the risks facing China Everbright Greentech we've found 3 warning signs (1 is potentially serious!) that you should be aware of before investing here.

While China Everbright Greentech 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.