Should You Be Impressed By HK Electric Investments and HK Electric Investments' (HKG:2638) Returns on Capital?

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think HK Electric Investments and HK Electric Investments (HKG:2638) 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. Analysts use this formula to calculate it for HK Electric Investments and HK Electric Investments:

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

0.048 = HK$4.3b ÷ (HK$111b - HK$23b) (Based on the trailing twelve months to June 2020).

So, HK Electric Investments and HK Electric Investments has an ROCE of 4.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.8%.

View our latest analysis for HK Electric Investments and HK Electric Investments

In the above chart we have measured HK Electric Investments and HK Electric Investments' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

There hasn't been much to report for HK Electric Investments and HK Electric Investments' returns and its level of capital employed because both metrics have been steady for the past five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So don't be surprised if HK Electric Investments and HK Electric Investments doesn't end up being a multi-bagger in a few years time. That being the case, it makes sense that HK Electric Investments and HK Electric Investments has been paying out 112% of its earnings to its shareholders. Most shareholders probably know this and own the stock for its dividend.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 21% of total assets, this reported ROCE would probably be less than4.8% because total capital employed would be higher.The 4.8% ROCE could be even lower if current liabilities weren't 21% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.

The Bottom Line On HK Electric Investments and HK Electric Investments' ROCE

In summary, HK Electric Investments and HK Electric Investments isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 50% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing to note, we've identified 2 warning signs with HK Electric Investments and HK Electric Investments and understanding them should be part of your investment process.

While HK Electric Investments and HK Electric Investments 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. 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.
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