China Wan Tong Yuan (Holdings) (HKG:6966) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after briefly looking over the numbers, we don't think China Wan Tong Yuan (Holdings) (HKG:6966) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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 China Wan Tong Yuan (Holdings), this is the formula:

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

0.08 = CN¥25m ÷ (CN¥330m - CN¥21m) (Based on the trailing twelve months to December 2023).

So, China Wan Tong Yuan (Holdings) has an ROCE of 8.0%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 12%.

View our latest analysis for China Wan Tong Yuan (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'd like to look at how China Wan Tong Yuan (Holdings) has performed in the past in other metrics, you can view this free graph of China Wan Tong Yuan (Holdings)'s past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at China Wan Tong Yuan (Holdings) doesn't inspire confidence. To be more specific, ROCE has fallen from 14% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, China Wan Tong Yuan (Holdings) has done well to pay down its current liabilities to 6.4% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 China Wan Tong Yuan (Holdings)'s ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for China Wan Tong Yuan (Holdings). And the stock has done incredibly well with a 150% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for China Wan Tong Yuan (Holdings) (of which 2 are significant!) that you should know about.

While China Wan Tong Yuan (Holdings) 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com