The Returns On Capital At Deyun Holding (HKG:1440) Don't Inspire Confidence

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Deyun Holding (HKG:1440), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Deyun Holding:

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

0.073 = CN¥25m ÷ (CN¥380m - CN¥43m) (Based on the trailing twelve months to December 2021).

Thus, Deyun Holding has an ROCE of 7.3%. In absolute terms, that's a low return but it's around the Luxury industry average of 9.0%.

Check out our latest analysis for Deyun Holding

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

What Can We Tell From Deyun Holding's ROCE Trend?

On the surface, the trend of ROCE at Deyun Holding doesn't inspire confidence. Around four years ago the returns on capital were 17%, but since then they've fallen to 7.3%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Deyun Holding has done well to pay down its current liabilities to 11% 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 Deyun Holding's ROCE

We're a bit apprehensive about Deyun Holding because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 28% return over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Deyun Holding does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those can't be ignored...

While Deyun Holding 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.