Investors Will Want YuanShengTai Dairy Farm's (HKG:1431) Growth In ROCE To Persist

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. With that in mind, we've noticed some promising trends at YuanShengTai Dairy Farm (HKG:1431) so let's look a bit deeper.

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. The formula for this calculation on YuanShengTai Dairy Farm is:

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

0.063 = CN¥386m ÷ (CN¥7.7b - CN¥1.6b) (Based on the trailing twelve months to June 2023).

Thus, YuanShengTai Dairy Farm has an ROCE of 6.3%. Ultimately, that's a low return and it under-performs the Food industry average of 9.3%.

View our latest analysis for YuanShengTai Dairy Farm

Historical performance is a great place to start when researching a stock so above you can see the gauge for YuanShengTai Dairy Farm's ROCE against it's prior returns. If you'd like to look at how YuanShengTai Dairy Farm has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is YuanShengTai Dairy Farm's ROCE Trending?

We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 6.3%. Basically the business is earning more per dollar of capital invested and in addition to that, 30% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 21% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line

To sum it up, YuanShengTai Dairy Farm has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Given the stock has declined 40% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.

YuanShengTai Dairy Farm does have some risks though, and we've spotted 2 warning signs for YuanShengTai Dairy Farm that you might be interested in.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.