Returns On Capital Are Showing Encouraging Signs At China Modern Dairy Holdings (HKG:1117)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at China Modern Dairy Holdings (HKG:1117) and its trend of ROCE, we really liked what we saw.

What is 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. To calculate this metric for China Modern Dairy Holdings, this is the formula:

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).

Therefore, China Modern Dairy Holdings has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 13% it's much better.

Check out 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. The figures show that over the last five years, ROCE has grown 93% whilst employing roughly the same amount of capital. 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.

One more thing to note, China Modern Dairy Holdings has decreased current liabilities to 22% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

In Conclusion...

As discussed above, China Modern Dairy Holdings appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 25% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

On a final note, we've found 4 warning signs for China Modern Dairy Holdings that we think you should be aware of.

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.
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