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

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing 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)

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)

0.091 = HK$9.9b ÷ (HK$163b - HK$54b) (Based on the trailing twelve months to March 2022).

Therefore, China Gas Holdings has an ROCE of 9.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.1%.

Check out the opportunities and risks within the HK Gas Utilities industry.

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.

What Can We Tell From China Gas Holdings' ROCE Trend?

On the surface, the trend of ROCE at China Gas Holdings doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 9.1%. 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.

What We Can Learn From China Gas Holdings' ROCE

While returns have fallen for China Gas Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 58% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One final note, you should learn about the 3 warning signs we've spotted with China Gas Holdings (including 1 which doesn't sit too well with us) .

While China Gas Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.