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

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Deyun Holding (HKG:1440) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Deyun Holding, this is the formula:

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

0.011 = CN¥3.9m ÷ (CN¥382m - CN¥40m) (Based on the trailing twelve months to June 2022).

So, Deyun Holding has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the Luxury industry average of 11%.

See 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 Does the ROCE Trend For Deyun Holding Tell Us?

In terms of Deyun Holding's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 23%, but since then they've fallen to 1.1%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Deyun Holding has done well to pay down its current liabilities to 10% 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. 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.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Deyun Holding have fallen, meanwhile the business is employing more capital than it was four years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 76% return over the last year, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Deyun Holding does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

While Deyun Holding isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.