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

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. 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)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its 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)

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

Thus, China Modern Dairy Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 8.8% it's much better.

View our latest analysis for China Modern Dairy Holdings

In the above chart we have measured China Modern Dairy Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Modern Dairy Holdings.

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

China Modern Dairy Holdings is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially 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%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

One more thing to note, China Modern Dairy Holdings has decreased current liabilities to 26% 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...

All in all, it's terrific to see that China Modern Dairy Holdings is reaping the rewards from prior investments and is growing its capital base. And since the stock has fallen 19% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.

If you'd like to know more about China Modern Dairy Holdings, we've spotted 4 warning signs, and 1 of them makes us a bit uncomfortable.

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.