Be Wary Of Zhongyu Energy Holdings (HKG:3633) And Its Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 investigating Zhongyu Energy Holdings (HKG:3633), we don't think it's current trends fit the mold of a multi-bagger.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Zhongyu Energy Holdings:

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

0.074 = HK$1.4b ÷ (HK$27b - HK$8.4b) (Based on the trailing twelve months to December 2021).

Thus, Zhongyu Energy Holdings has an ROCE of 7.4%. Ultimately, that's a low return and it under-performs the Gas Utilities industry average of 10%.

View our latest analysis for Zhongyu Energy Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Zhongyu Energy Holdings, check out these free graphs here.

The Trend Of ROCE

On the surface, the trend of ROCE at Zhongyu Energy Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 9.3% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On Zhongyu Energy Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Zhongyu Energy Holdings. And the stock has done incredibly well with a 238% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you'd like to know more about Zhongyu Energy Holdings, we've spotted 2 warning signs, and 1 of them is a bit unpleasant.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.