When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Zhengzhou Coal Industry & Electric Power (SHSE:600121), so let's see why.
Return On Capital Employed (ROCE): What Is It?
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 Zhengzhou Coal Industry & Electric Power is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = CN¥461m ÷ (CN¥13b - CN¥9.8b) (Based on the trailing twelve months to September 2023).
Thus, Zhengzhou Coal Industry & Electric Power has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Oil and Gas industry average of 12%.
See our latest analysis for Zhengzhou Coal Industry & Electric Power
Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhengzhou Coal Industry & Electric Power's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Zhengzhou Coal Industry & Electric Power, check out these free graphs here.
The Trend Of ROCE
In terms of Zhengzhou Coal Industry & Electric Power's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 16% five years ago but has since fallen to 13%. In addition to that, Zhengzhou Coal Industry & Electric Power is now employing 30% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
On a side note, Zhengzhou Coal Industry & Electric Power's current liabilities have increased over the last five years to 73% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
What We Can Learn From Zhengzhou Coal Industry & Electric Power's ROCE
In summary, it's unfortunate that Zhengzhou Coal Industry & Electric Power is shrinking its capital base and also generating lower returns. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 95% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you're still interested in Zhengzhou Coal Industry & Electric Power it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
While Zhengzhou Coal Industry & Electric Power 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.
