The Returns On Capital At Luyan PharmaLtd (SZSE:002788) Don't Inspire Confidence

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Luyan PharmaLtd (SZSE:002788) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Luyan PharmaLtd is:

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

0.18 = CN¥702m ÷ (CN¥12b - CN¥8.0b) (Based on the trailing twelve months to June 2024).

Therefore, Luyan PharmaLtd has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 8.7% it's much better.

See our latest analysis for Luyan PharmaLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Luyan PharmaLtd'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 Luyan PharmaLtd.

How Are Returns Trending?

When we looked at the ROCE trend at Luyan PharmaLtd, we didn't gain much confidence. To be more specific, ROCE has fallen from 24% over the last five years. However it looks like Luyan PharmaLtd 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Luyan PharmaLtd's current liabilities are still rather high at 67% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Luyan PharmaLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Luyan PharmaLtd's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 27% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing, we've spotted 2 warning signs facing Luyan PharmaLtd that you might find interesting.

While Luyan PharmaLtd 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.