To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at Henan Dayou Energy (SHSE:600403), we've spotted some signs that it could be struggling, so let's investigate.
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. The formula for this calculation on Henan Dayou Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.056 = CN¥579m ÷ (CN¥22b - CN¥11b) (Based on the trailing twelve months to September 2023).
So, Henan Dayou Energy has an ROCE of 5.6%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Henan Dayou Energy's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Henan Dayou Energy.
The Trend Of ROCE
In terms of Henan Dayou Energy's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Henan Dayou Energy to turn into a multi-bagger.
On a separate but related note, it's important to know that Henan Dayou Energy has a current liabilities to total assets ratio of 52%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Henan Dayou Energy's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. In spite of that, the stock has delivered a 1.4% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
If you'd like to know more about Henan Dayou Energy, we've spotted 3 warning signs, and 1 of them shouldn't be ignored.
While Henan Dayou Energy 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.
