Dragon Mining (HKG:1712) Could Be Struggling To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Dragon Mining (HKG:1712) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Dragon Mining, this is the formula:

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

0.032 = AU$2.7m ÷ (AU$95m - AU$11m) (Based on the trailing twelve months to December 2021).

Thus, Dragon Mining has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 14%.

View our latest analysis for Dragon Mining

Historical performance is a great place to start when researching a stock so above you can see the gauge for Dragon Mining's ROCE against it's prior returns. If you're interested in investigating Dragon Mining's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Dragon Mining's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 3.2%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Dragon Mining have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last three years have experienced a 64% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 3 warning signs with Dragon Mining and understanding them should be part of your investment process.

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.