If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Chengdu Gas Group (SHSE:603053), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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 Chengdu Gas Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.097 = CN¥468m ÷ (CN¥7.9b - CN¥3.1b) (Based on the trailing twelve months to September 2023).
Thus, Chengdu Gas Group has an ROCE of 9.7%. On its own, that's a low figure but it's around the 9.2% average generated by the Gas Utilities industry.
Check out our latest analysis for Chengdu Gas Group
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 want to delve into the historical earnings, revenue and cash flow of Chengdu Gas Group, check out these free graphs here.
So How Is Chengdu Gas Group's ROCE Trending?
On the surface, the trend of ROCE at Chengdu Gas Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.7% from 19% five years ago. 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 side note, Chengdu Gas Group has done well to pay down its current liabilities to 39% 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.
The Bottom Line
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Chengdu Gas Group. These growth trends haven't led to growth returns though, since the stock has fallen 21% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
One more thing to note, we've identified 1 warning sign with Chengdu Gas Group and understanding it should be part of your investment process.
While Chengdu Gas Group 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.
