Investors Could Be Concerned With China Gas Holdings' (HKG:384) Returns On Capital

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after briefly looking over the numbers, we don't think China Gas Holdings (HKG:384) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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 China Gas Holdings, this is the formula:

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).

Thus, China Gas Holdings has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 8.9% generated by the Gas Utilities industry.

Check out 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

When we looked at the ROCE trend at China Gas Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 10%. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, China Gas Holdings has done well to pay down its current liabilities to 27% of total assets. That could partly explain why the ROCE has dropped. 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.

Our Take On 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 the stock has followed suit returning a meaningful 66% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you want to know some of the risks facing China Gas Holdings we've found 4 warning signs (1 doesn't sit too well with us!) 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.