China Gas Holdings (HKG:384) Could Be Struggling To Allocate Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. 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. Analysts use this formula to calculate it for China Gas Holdings:

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

0.10 = HK$12b ÷ (HK$155b - HK$41b) (Based on the trailing twelve months to September 2021).

So, China Gas Holdings has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 10%.

Check out our latest analysis for China Gas Holdings

Above you can see how the current ROCE for China Gas Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free 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. To be more specific, ROCE has fallen from 14% 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.

On a related note, China Gas Holdings has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From China Gas Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that China Gas Holdings is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 20% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

China Gas Holdings does have some risks, we noticed 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.