China Modern Dairy Holdings (HKG:1117) Is Looking To Continue Growing Its Returns On Capital

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in China Modern Dairy Holdings' (HKG:1117) returns on capital, so let's have a look.

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. 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)

0.16 = CN¥2.0b ÷ (CN¥16b - CN¥3.6b) (Based on the trailing twelve months to June 2021).

So, China Modern Dairy Holdings has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.8% generated by the Food industry.

See 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From China Modern Dairy Holdings' ROCE Trend?

China Modern Dairy Holdings is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 93% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 22%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. 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 bring it all together, China Modern Dairy Holdings has done well to increase the returns it's generating from its capital employed. And since the stock has fallen 28% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing to note, we've identified 2 warning signs with China Modern Dairy Holdings and understanding them should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.