What We Make Of Ouhua Energy Holdings' (SGX:AJ2) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at Ouhua Energy Holdings (SGX:AJ2) so let's look a bit deeper.

What is 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. Analysts use this formula to calculate it for Ouhua Energy Holdings:

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

0.067 = CN¥14m ÷ (CN¥458m - CN¥251m) (Based on the trailing twelve months to June 2020).

Thus, Ouhua Energy Holdings has an ROCE of 6.7%. On its own that's a low return, but compared to the average of 4.9% generated by the Oil and Gas industry, it's much better.

Check out our latest analysis for Ouhua Energy Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. 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 Does the ROCE Trend For Ouhua Energy Holdings Tell Us?

Ouhua Energy Holdings has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 6.7% on its capital. Not only that, but the company is utilizing 282% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 55%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books. However, current liabilities are still at a pretty high level, so just be aware that this can bring with it some risks.

The Bottom Line On Ouhua Energy Holdings' ROCE

Overall, Ouhua Energy Holdings gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Astute investors may have an opportunity here because the stock has declined 60% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

One more thing to note, we've identified 3 warning signs with Ouhua Energy Holdings and understanding these should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. 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.
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