Here's What's Concerning About China Youran Dairy Group's (HKG:9858) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. 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)

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 Youran Dairy Group, this is the formula:

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

0.12 = CN¥2.9b ÷ (CN¥43b - CN¥20b) (Based on the trailing twelve months to December 2022).

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 9.8% 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For China Youran Dairy Group Tell Us?

In terms of China Youran Dairy Group's historical ROCE movements, the trend isn't fantastic. Over the last four years, returns on capital have decreased to 12% from 16% four years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 46%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 12%. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that China Youran Dairy Group is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 36% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing: We've identified 3 warning signs with China Youran Dairy Group (at least 2 which don't sit too well with us) , and understanding them would certainly be useful.

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.