Taizhou Water Group (HKG:1542) May Have Issues Allocating Its Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Taizhou Water Group (HKG:1542) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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. The formula for this calculation on Taizhou Water Group is:

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

0.044 = CN¥171m ÷ (CN¥4.9b - CN¥968m) (Based on the trailing twelve months to December 2021).

Thus, Taizhou Water Group has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Water Utilities industry average of 8.1%.

Check out our latest analysis for Taizhou Water 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 Taizhou Water Group's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Taizhou Water Group's ROCE Trend?

When we looked at the ROCE trend at Taizhou Water Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 6.1% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Taizhou Water Group has done well to pay down its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

To conclude, we've found that Taizhou Water Group is reinvesting in the business, but returns have been falling. Unsurprisingly then, the total return to shareholders over the last year has been flat. Therefore based on the analysis done in this article, we don't think Taizhou Water Group has the makings of a multi-bagger.

If you want to know some of the risks facing Taizhou Water Group we've found 3 warning signs (1 is significant!) that you should be aware of before investing here.

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.

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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.