Returns On Capital At Zhengye International Holdings (HKG:3363) Paint An Interesting Picture

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 investigating Zhengye International Holdings (HKG:3363), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

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 Zhengye International Holdings, this is the formula:

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

0.054 = CN¥70m ÷ (CN¥2.4b - CN¥1.2b) (Based on the trailing twelve months to June 2020).

So, Zhengye International Holdings has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Packaging industry average of 11%.

View our latest analysis for Zhengye International Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Zhengye International Holdings, check out these free graphs here.

So How Is Zhengye International Holdings' ROCE Trending?

In terms of Zhengye International Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% over the last five years. 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.

On a related note, Zhengye International Holdings has decreased its current liabilities to 47% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

We're a bit apprehensive about Zhengye International Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. In spite of that, the stock has delivered a 0.5% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you'd like to know more about Zhengye International Holdings, we've spotted 4 warning signs, and 1 of them doesn't sit too well with us.

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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