Should You Be Impressed By CGN New Energy Holdings' (HKG:1811) 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. However, after briefly looking over the numbers, we don't think CGN New Energy Holdings (HKG:1811) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 CGN New Energy Holdings, this is the formula:

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

0.06 = US$258m ÷ (US$5.9b - US$1.5b) (Based on the trailing twelve months to June 2020).

Therefore, CGN New Energy Holdings has an ROCE of 6.0%. In absolute terms, that's a low return but it's around the Renewable Energy industry average of 7.3%.

See 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'd like to see what analysts are forecasting going forward, you should check out our free report for CGN New Energy Holdings.

The Trend Of ROCE

In terms of CGN New Energy Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.0% from 7.6% five years ago. 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, CGN New Energy Holdings' current liabilities have increased over the last five years to 26% 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. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

What We Can Learn From CGN New Energy Holdings' ROCE

In summary, CGN New Energy Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Yet to long term shareholders the stock has gifted them an incredible 152% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One final note, you should learn about the 3 warning signs we've spotted with CGN New Energy Holdings (including 2 which make us uncomfortable) .

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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