Capital Allocation Trends At China Gas Holdings (HKG:384) Aren't Ideal

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at China Gas Holdings (HKG:384), it didn't seem to tick all of these boxes.

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. The formula for this calculation on China Gas Holdings is:

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

0.057 = HK$5.6b ÷ (HK$149b - HK$50b) (Based on the trailing twelve months to March 2024).

Thus, China Gas Holdings has an ROCE of 5.7%. In absolute terms, that's a low return and it also under-performs the Gas Utilities industry average of 8.6%.

View our latest analysis for China Gas Holdings

In the above chart we have measured China Gas Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for China Gas Holdings .

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

On the surface, the trend of ROCE at China Gas Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.7% from 15% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

What We Can Learn From China Gas Holdings' ROCE

We're a bit apprehensive about China Gas Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Unsurprisingly then, the stock has dived 72% over the last five years, so investors are recognizing these changes and don't like the company's prospects. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

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

While China Gas Holdings 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.