CGN Power (HKG:1816) Shareholders Will Want The ROCE Trajectory To Continue

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, CGN Power (HKG:1816) looks quite promising in regards to its trends of return on capital.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for CGN Power, this is the formula:

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

0.076 = CN¥24b ÷ (CN¥394b - CN¥78b) (Based on the trailing twelve months to March 2021).

So, CGN Power has an ROCE of 7.6%. In absolute terms, that's a low return but it's around the Renewable Energy industry average of 7.2%.

Check out our latest analysis for CGN Power

Above you can see how the current ROCE for CGN Power compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering CGN Power here for free.

The Trend Of ROCE

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 7.6%. Basically the business is earning more per dollar of capital invested and in addition to that, 56% 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.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 20% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On CGN Power's ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what CGN Power has. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we found 2 warning signs for CGN Power (1 is a bit unpleasant) you should be aware of.

While CGN Power 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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