China Wan Tong Yuan (Holdings)'s (HKG:6966) Returns On Capital Not Reflecting Well On The Business

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at China Wan Tong Yuan (Holdings) (HKG:6966) 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. Analysts use this formula to calculate it for China Wan Tong Yuan (Holdings):

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

0.076 = CN¥19m ÷ (CN¥261m - CN¥16m) (Based on the trailing twelve months to June 2021).

Thus, China Wan Tong Yuan (Holdings) has an ROCE of 7.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.8%.

Check out 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 past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at China Wan Tong Yuan (Holdings), we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.6% from 20% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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 related note, China Wan Tong Yuan (Holdings) has decreased its current liabilities to 6.0% of total assets. So we could link some of this to the decrease in ROCE. 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. 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 China Wan Tong Yuan (Holdings) have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 80% return to shareholders over the last three years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Like most companies, China Wan Tong Yuan (Holdings) does come with some risks, and we've found 2 warning signs that you should be aware of.

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.

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.

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