Dongyue Group (HKG:189) Might Be Having Difficulty Using Its Capital Effectively

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. However, after briefly looking over the numbers, we don't think Dongyue Group (HKG:189) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. Analysts use this formula to calculate it for Dongyue Group:

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

0.09 = CN¥1.6b ÷ (CN¥23b - CN¥5.9b) (Based on the trailing twelve months to June 2023).

So, Dongyue Group has an ROCE of 9.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.3%.

Check out our latest analysis for Dongyue Group

In the above chart we have measured Dongyue 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 Can We Tell From Dongyue Group's ROCE Trend?

When we looked at the ROCE trend at Dongyue Group, we didn't gain much confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 9.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

In Conclusion...

In summary, we're somewhat concerned by Dongyue Group's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 49% 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.

Dongyue Group does have some risks though, and we've spotted 2 warning signs for Dongyue Group that you might be interested in.

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.