If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Towngas Smart Energy (HKG:1083) and its ROCE trend, we weren't exactly thrilled.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Towngas Smart Energy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.053 = HK$1.8b ÷ (HK$54b - HK$20b) (Based on the trailing twelve months to June 2024).
Thus, Towngas Smart Energy has an ROCE of 5.3%. In absolute terms, that's a low return and it also under-performs the Gas Utilities industry average of 8.6%.
Above you can see how the current ROCE for Towngas Smart Energy compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Towngas Smart Energy for free.
The Trend Of ROCE
When we looked at the ROCE trend at Towngas Smart Energy, we didn't gain much confidence. Around five years ago the returns on capital were 6.7%, but since then they've fallen to 5.3%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
In summary, Towngas Smart Energy is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 37% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
On a final note, we found 3 warning signs for Towngas Smart Energy (1 is significant) you should be aware of.
While Towngas Smart Energy 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.
