Be Wary Of Taizhou Water Group (HKG:1542) And Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Taizhou Water Group (HKG:1542), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Taizhou Water Group is:

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

0.014 = CN¥62m ÷ (CN¥5.8b - CN¥1.2b) (Based on the trailing twelve months to June 2024).

Thus, Taizhou Water Group has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Water Utilities industry average of 6.1%.

View our latest analysis for Taizhou Water Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Taizhou Water Group's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Taizhou Water Group.

How Are Returns Trending?

When we looked at the ROCE trend at Taizhou Water Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.4% from 7.7% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 21%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.4%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Taizhou Water Group's ROCE

Bringing it all together, while we're somewhat encouraged by Taizhou Water Group's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 15% in the last three years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

If you'd like to know more about Taizhou Water Group, we've spotted 3 warning signs, and 2 of them make us uncomfortable.

While Taizhou Water 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.