Yadong Group Holdings (HKG:1795) 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'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Yadong Group Holdings (HKG:1795), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Yadong Group Holdings:

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

0.15 = CN¥42m ÷ (CN¥778m - CN¥497m) (Based on the trailing twelve months to June 2023).

So, Yadong Group Holdings has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 11% it's much better.

See our latest analysis for Yadong Group Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Yadong Group Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Yadong Group Holdings' ROCE Trend?

When we looked at the ROCE trend at Yadong Group Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 41% over the last five years. 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'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.

Another thing to note, Yadong Group Holdings has a high ratio of current liabilities to total assets of 64%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Yadong Group Holdings' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 574% gain to shareholders who have held over the last three years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Yadong Group Holdings (of which 2 are significant!) that you should know about.

While Yadong Group Holdings 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.