Investors Could Be Concerned With Ouhua Energy Holdings' (SGX:AJ2) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. So while Ouhua Energy Holdings (SGX:AJ2) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Ouhua Energy Holdings is:

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

0.27 = CN¥70m ÷ (CN¥740m - CN¥483m) (Based on the trailing twelve months to June 2022).

So, Ouhua Energy Holdings has an ROCE of 27%. On its own that's a fantastic return on capital, though it's the same as the Oil and Gas industry average of 27%.

View our latest analysis for Ouhua Energy Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Ouhua Energy Holdings' ROCE against it's prior returns. If you'd like to look at how Ouhua Energy Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Ouhua Energy Holdings' historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 43%, but they have dropped 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Ouhua Energy Holdings has decreased its current liabilities to 65% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Ouhua Energy Holdings is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 11% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you'd like to know more about Ouhua Energy Holdings, we've spotted 4 warning signs, and 1 of them is a bit unpleasant.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.