China Ludao Technology (HKG:2023) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at China Ludao Technology (HKG:2023), it didn't seem to tick all of these boxes.

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. The formula for this calculation on China Ludao Technology is:

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

0.021 = CN¥18m ÷ (CN¥1.2b - CN¥267m) (Based on the trailing twelve months to December 2022).

So, China Ludao Technology has an ROCE of 2.1%. Ultimately, that's a low return and it under-performs the Household Products industry average of 5.7%.

Check out our latest analysis for China Ludao Technology

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

What Can We Tell From China Ludao Technology's ROCE Trend?

In terms of China Ludao Technology's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 7.6%, but since then they've fallen to 2.1%. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, China Ludao Technology has decreased its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for China Ludao Technology. These growth trends haven't led to growth returns though, since the stock has fallen 23% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for China Ludao Technology (of which 1 is a bit concerning!) that you should know about.

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.