Jiangxi Sunshine Dairy (SZSE:001318) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 briefly looking over the numbers, we don't think Jiangxi Sunshine Dairy (SZSE:001318) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. To calculate this metric for Jiangxi Sunshine Dairy, this is the formula:

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

0.071 = CN¥100m ÷ (CN¥1.5b - CN¥59m) (Based on the trailing twelve months to September 2024).

Therefore, Jiangxi Sunshine Dairy has an ROCE of 7.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.8%.

See our latest analysis for Jiangxi Sunshine Dairy

Historical performance is a great place to start when researching a stock so above you can see the gauge for Jiangxi Sunshine Dairy's ROCE against it's prior returns. If you're interested in investigating Jiangxi Sunshine Dairy's past further, check out this free graph covering Jiangxi Sunshine Dairy's past earnings, revenue and cash flow.

So How Is Jiangxi Sunshine Dairy's ROCE Trending?

In terms of Jiangxi Sunshine Dairy's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 22%, but since then they've fallen to 7.1%. However it looks like Jiangxi Sunshine Dairy might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Jiangxi Sunshine Dairy has done well to pay down its current liabilities to 4.0% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Jiangxi Sunshine Dairy's ROCE

In summary, Jiangxi Sunshine Dairy is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 28% over the last year. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing to note, we've identified 1 warning sign with Jiangxi Sunshine Dairy and understanding it should be part of your investment process.

While Jiangxi Sunshine Dairy 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.

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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.