What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Hunan Heshun PetroleumLtd (SHSE:603353), we don't think it's current trends fit the mold of a multi-bagger.
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. Analysts use this formula to calculate it for Hunan Heshun PetroleumLtd:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = CN¥61m ÷ (CN¥2.1b - CN¥248m) (Based on the trailing twelve months to September 2024).
So, Hunan Heshun PetroleumLtd has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 5.0%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hunan Heshun PetroleumLtd's ROCE against it's prior returns. If you'd like to look at how Hunan Heshun PetroleumLtd has performed in the past in other metrics, you can view this free graph of Hunan Heshun PetroleumLtd's past earnings, revenue and cash flow.
The Trend Of ROCE
In terms of Hunan Heshun PetroleumLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.3% from 35% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a related note, Hunan Heshun PetroleumLtd has decreased its current liabilities to 12% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
In Conclusion...
From the above analysis, we find it rather worrisome that returns on capital and sales for Hunan Heshun PetroleumLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 40% from where it was three years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
One more thing to note, we've identified 1 warning sign with Hunan Heshun PetroleumLtd and understanding it should be part of your investment process.
While Hunan Heshun PetroleumLtd 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
