Some Investors May Be Worried About Guangdong Investment's (HKG:270) 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? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. 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)

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 Guangdong Investment:

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

0.062 = HK$5.9b ÷ (HK$140b - HK$46b) (Based on the trailing twelve months to March 2024).

Therefore, Guangdong Investment has an ROCE of 6.2%. Even though it's in line with the industry average of 6.2%, it's still a low return by itself.

View our latest analysis for Guangdong Investment

In the above chart we have measured Guangdong Investment's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Guangdong Investment for free.

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 8.8% over the last five years. However it looks like Guangdong Investment might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 33%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 6.2%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On Guangdong Investment's ROCE

In summary, Guangdong Investment is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 66% in the last five years. Therefore based on the analysis done in this article, we don't think Guangdong Investment has the makings of a multi-bagger.

Guangdong Investment does have some risks though, and we've spotted 3 warning signs for Guangdong Investment that you might be interested in.

While Guangdong Investment 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. 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.