China Oil And Gas Group (HKG:603) May Have Issues Allocating Its Capital

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at China Oil And Gas Group (HKG:603), it didn't seem to tick all of these boxes.

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. The formula for this calculation on China Oil And Gas Group is:

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

0.067 = HK$971m ÷ (HK$20b - HK$5.8b) (Based on the trailing twelve months to June 2024).

Therefore, China Oil And Gas Group has an ROCE of 6.7%. Ultimately, that's a low return and it under-performs the Gas Utilities industry average of 8.6%.

Check out our latest analysis for China Oil And Gas Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Oil And Gas Group's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of China Oil And Gas Group.

So How Is China Oil And Gas Group's ROCE Trending?

On the surface, the trend of ROCE at China Oil And Gas Group doesn't inspire confidence. Around five years ago the returns on capital were 9.5%, but since then they've fallen to 6.7%. 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 side note, China Oil And Gas Group has done well to pay down its current liabilities to 29% 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. 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.

What We Can Learn From China Oil And Gas Group's ROCE

In summary, China Oil And Gas Group 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 48% 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.

China Oil And Gas Group does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those make us uncomfortable...

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.