Investors Could Be Concerned With Guangdong Investment's (HKG:270) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. In light of that, when we looked at Guangdong Investment (HKG:270) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Guangdong Investment:

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

0.075 = HK$7.6b ÷ (HK$134b - HK$33b) (Based on the trailing twelve months to June 2022).

So, Guangdong Investment has an ROCE of 7.5%. In absolute terms, that's a low return but it's around the Water Utilities industry average of 7.1%.

Our analysis indicates that 270 is potentially undervalued!

Above you can see how the current ROCE for Guangdong Investment 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 The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Guangdong Investment, we didn't gain much confidence. To be more specific, ROCE has fallen from 9.8% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

Our Take On Guangdong Investment's ROCE

To conclude, we've found that Guangdong Investment is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 28% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

If you want to know some of the risks facing Guangdong Investment we've found 3 warning signs (2 make us uncomfortable!) that you should be aware of before investing here.

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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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.