CGN New Energy Holdings (HKG:1811) Is Experiencing Growth In Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. So on that note, CGN New Energy Holdings (HKG:1811) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for CGN New Energy Holdings:

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

0.058 = US$287m ÷ (US$7.0b - US$2.0b) (Based on the trailing twelve months to December 2020).

Therefore, CGN New Energy Holdings has an ROCE of 5.8%. In absolute terms, that's a low return but it's around the Renewable Energy industry average of 7.2%.

View our latest analysis for CGN New Energy Holdings

Above you can see how the current ROCE for CGN New Energy Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For CGN New Energy Holdings Tell Us?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 5.8%. Basically the business is earning more per dollar of capital invested and in addition to that, 47% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 29% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

What We Can Learn From CGN New Energy Holdings' ROCE

In summary, it's great to see that CGN New Energy Holdings can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if CGN New Energy Holdings can keep these trends up, it could have a bright future ahead.

One final note, you should learn about the 4 warning signs we've spotted with CGN New Energy Holdings (including 2 which make us uncomfortable) .

While CGN New Energy Holdings 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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