What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Hengsheng Energy (SHSE:605580), 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. To calculate this metric for Hengsheng Energy, this is the formula:

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

0.15 = CN¥156m ÷ (CN¥1.3b - CN¥256m) (Based on the trailing twelve months to September 2023).

Thus, Hengsheng Energy has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Integrated Utilities industry average of 5.0% it's much better.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hengsheng Energy's ROCE against it's prior returns. If you're interested in investigating Hengsheng Energy's past further, check out this free graph covering Hengsheng Energy's past earnings, revenue and cash flow.

What Does the ROCE Trend For Hengsheng Energy Tell Us?

On the surface, the trend of ROCE at Hengsheng Energy doesn't inspire confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 15%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Hengsheng Energy has decreased its current liabilities to 20% 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.

The Key Takeaway

In summary, Hengsheng Energy is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 8.6% over the last year, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we found 2 warning signs for Hengsheng Energy (1 is a bit unpleasant) you should be aware of.

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. 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.