China Modern Dairy Holdings (HKG:1117) Is Experiencing Growth In Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, China Modern Dairy Holdings (HKG:1117) looks quite promising in regards to its trends of return on capital.

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

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 Modern Dairy Holdings:

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

0.12 = CN¥2.2b ÷ (CN¥25b - CN¥6.6b) (Based on the trailing twelve months to June 2022).

So, China Modern Dairy Holdings has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 8.7% generated by the Food industry.

View our latest analysis for China Modern Dairy Holdings

Above you can see how the current ROCE for China Modern Dairy Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Modern Dairy Holdings here for free.

How Are Returns Trending?

We like the trends that we're seeing from China Modern Dairy Holdings. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 12%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 87%. So we're very much inspired by what we're seeing at China Modern Dairy Holdings thanks to its ability to profitably reinvest capital.

On a related note, the company's ratio of current liabilities to total assets has decreased to 26%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

Our Take On China Modern Dairy Holdings' ROCE

To sum it up, China Modern Dairy Holdings has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Astute investors may have an opportunity here because the stock has declined 31% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing: We've identified 4 warning signs with China Modern Dairy Holdings (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

While China Modern Dairy 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.