What financial metrics can indicate to us that a company is maturing or even in decline? 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. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into Huadian Power International (HKG:1071), the trends above didn't look too great.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Huadian Power International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = CN¥6.3b ÷ (CN¥221b - CN¥65b) (Based on the trailing twelve months to March 2024).
So, Huadian Power International has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 6.7%.
See our latest analysis for Huadian Power International
In the above chart we have measured Huadian Power International's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Huadian Power International .
What Can We Tell From Huadian Power International's ROCE Trend?
In terms of Huadian Power International's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 5.8%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Huadian Power International to turn into a multi-bagger.
The Key Takeaway
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 78% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you'd like to know more about Huadian Power International, we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
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