China Youran Dairy Group (HKG:9858) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating China Youran Dairy Group (HKG:9858), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. Analysts use this formula to calculate it for China Youran Dairy Group:

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

0.12 = CN¥2.8b ÷ (CN¥46b - CN¥23b) (Based on the trailing twelve months to June 2023).

Therefore, China Youran Dairy Group has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 9.3% generated by the Food industry.

View our latest analysis for China Youran Dairy Group

In the above chart we have measured China Youran Dairy Group's 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 China Youran Dairy Group here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at China Youran Dairy Group, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 12% from 16% four years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, China Youran Dairy Group's current liabilities have increased over the last four years to 50% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 12%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

In summary, China Youran Dairy Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last year, the stock has given away 38% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think China Youran Dairy Group has the makings of a multi-bagger.

One more thing, we've spotted 1 warning sign facing China Youran Dairy Group that you might find interesting.

While China Youran Dairy Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.