Capital Allocation Trends At China MeiDong Auto Holdings (HKG:1268) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at China MeiDong Auto Holdings (HKG:1268) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on China MeiDong Auto Holdings is:

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

0.059 = CN¥573m ÷ (CN¥14b - CN¥4.4b) (Based on the trailing twelve months to December 2023).

So, China MeiDong Auto Holdings has an ROCE of 5.9%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 10%.

Check out our latest analysis for China MeiDong Auto Holdings

In the above chart we have measured China MeiDong Auto Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China MeiDong Auto Holdings for free.

How Are Returns Trending?

When we looked at the ROCE trend at China MeiDong Auto Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 30%, but since then they've fallen to 5.9%. However it looks like China MeiDong Auto Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, China MeiDong Auto Holdings has done well to pay down its current liabilities to 31% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On China MeiDong Auto Holdings' ROCE

To conclude, we've found that China MeiDong Auto Holdings is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 22% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Like most companies, China MeiDong Auto Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.

While China MeiDong Auto Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.