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 indicates the company is producing less profit from its investments and its total assets are decreasing. In light of that, from a first glance at Huadian Power International (HKG:1071), we've spotted some signs that it could be struggling, so let's investigate.
Understanding 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. Analysts use this formula to calculate it for Huadian Power International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = CN¥6.4b ÷ (CN¥222b - CN¥63b) (Based on the trailing twelve months to September 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 7.0%.
Check out our latest analysis for Huadian Power International
Above you can see how the current ROCE for Huadian Power International 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 Huadian Power International for free.
How Are Returns Trending?
There is reason to be cautious about Huadian Power International, given the returns are trending downwards. About five years ago, returns on capital were 6.2%, 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Huadian Power International becoming one if things continue as they have.
The Bottom Line On Huadian Power International's ROCE
In summary, it's unfortunate that Huadian Power International is generating lower returns from the same amount of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 221%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Huadian Power International (of which 1 shouldn't be ignored!) that you should know about.
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.