There Are Reasons To Feel Uneasy About China Wan Tong Yuan (Holdings)'s (HKG:6966) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. 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.

Understanding 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. The formula for this calculation on China Wan Tong Yuan (Holdings) is:

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

0.073 = CN¥17m ÷ (CN¥253m - CN¥18m) (Based on the trailing twelve months to December 2020).

So, China Wan Tong Yuan (Holdings) has an ROCE of 7.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.5%.

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're interested in investigating China Wan Tong Yuan (Holdings)'s past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For China Wan Tong Yuan (Holdings) 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 7.3% from 19% five years ago. 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, China Wan Tong Yuan (Holdings) has done well to pay down its current liabilities to 7.1% of total assets. Considering it used to be 61%, that's a huge drop in that ratio and it would explain the decline in ROCE. 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.

In Conclusion...

We're a bit apprehensive about China Wan Tong Yuan (Holdings) because despite more capital being deployed in the business, returns on that capital and sales have both fallen. But investors must be expecting an improvement of sorts because over the last three yearsthe stock has delivered a respectable 59% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing, we've spotted 3 warning signs facing China Wan Tong Yuan (Holdings) that you might find interesting.

While China Wan Tong Yuan (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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