What Do The Returns On Capital At Zhongyu Gas Holdings (HKG:3633) Tell Us?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Zhongyu Gas Holdings (HKG:3633) looks decent, right now, so lets see what the trend of returns can tell us.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhongyu Gas Holdings, this is the formula:

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

0.11 = HK$1.4b ÷ (HK$21b - HK$8.2b) (Based on the trailing twelve months to June 2020).

Therefore, Zhongyu Gas Holdings has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.

See our latest analysis for Zhongyu Gas 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 Gas Holdings, check out these free graphs here.

How Are Returns Trending?

While the returns on capital are good, they haven't moved much. The company has consistently earned 11% for the last five years, and the capital employed within the business has risen 140% in that time. Since 11% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

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 39% of total assets, this reported ROCE would probably be less than11% because total capital employed would be higher.The 11% ROCE could be even lower if current liabilities weren't 39% 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

To sum it up, Zhongyu Gas Holdings has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 285% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One final note, you should learn about the 2 warning signs we've spotted with Zhongyu Gas Holdings (including 1 which shouldn't be ignored) .

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. 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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