Returns At Zhongyu Energy Holdings (HKG:3633) Appear To Be Weighed Down

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Zhongyu Energy Holdings (HKG:3633) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

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)

0.086 = HK$1.1b ÷ (HK$24b - HK$11b) (Based on the trailing twelve months to June 2021).

Therefore, Zhongyu Energy Holdings has an ROCE of 8.6%. Even though it's in line with the industry average of 8.9%, it's still a low return by itself.

See our latest analysis for Zhongyu Energy Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhongyu Energy Holdings' ROCE against it's prior returns. If you'd like to look at how Zhongyu Energy Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

There are better returns on capital out there than what we're seeing at Zhongyu Energy Holdings. The company has employed 129% more capital in the last five years, and the returns on that capital have remained stable at 8.6%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 47% of total assets, this reported ROCE would probably be less than8.6% because total capital employed would be higher.The 8.6% ROCE could be even lower if current liabilities weren't 47% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

The Bottom Line On Zhongyu Energy Holdings' ROCE

In conclusion, Zhongyu Energy Holdings has been investing more capital into the business, but returns on that capital haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 322% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to know some of the risks facing Zhongyu Energy Holdings we've found 2 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

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.