Zhongyu Gas Holdings (HKG:3633) Has More To Do To Multiply In Value Going Forward

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 Gas 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?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

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

So, Zhongyu Gas 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 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.

What Does the ROCE Trend For Zhongyu Gas Holdings Tell Us?

In terms of Zhongyu Gas Holdings' historical ROCE trend, it doesn't exactly demand attention. The company has employed 129% more capital in the last five years, and the returns on that capital have remained stable at 8.6%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

Another point to note, we noticed the company has increased current liabilities 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. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

What We Can Learn From Zhongyu Gas Holdings' ROCE

In summary, Zhongyu Gas Holdings has simply been reinvesting capital and generating the same low rate of return as before. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 270% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Zhongyu Gas Holdings does have some risks, we noticed 2 warning signs (and 1 which is concerning) we think you should know about.

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.

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.

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