Returns On Capital Signal Tricky Times Ahead For COFCO Joycome Foods (HKG:1610)

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Having said that, from a first glance at COFCO Joycome Foods (HKG:1610) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on COFCO Joycome Foods is:

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

0.0028 = CN¥23m ÷ (CN¥20b - CN¥11b) (Based on the trailing twelve months to June 2022).

So, COFCO Joycome Foods has an ROCE of 0.3%. Ultimately, that's a low return and it under-performs the Food industry average of 8.6%.

Check out the opportunities and risks within the HK Food industry.

In the above chart we have measured COFCO Joycome Foods' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering COFCO Joycome Foods here for free.

What The Trend Of ROCE Can Tell Us

In terms of COFCO Joycome Foods' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 25%, but since then they've fallen to 0.3%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 57%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line On COFCO Joycome Foods' ROCE

In summary, we're somewhat concerned by COFCO Joycome Foods' diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 69% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we've found 2 warning signs for COFCO Joycome Foods that we think you should be aware of.

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.