China MeiDong Auto Holdings' (HKG:1268) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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.

Understanding 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)

0.17 = CN¥1.5b ÷ (CN¥17b - CN¥7.4b) (Based on the trailing twelve months to June 2022).

Thus, China MeiDong Auto Holdings has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Specialty Retail industry average of 10% it's much better.

Check out our latest analysis for China MeiDong Auto Holdings

Above you can see how the current ROCE for China MeiDong Auto Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China MeiDong Auto Holdings.

What Can We Tell From China MeiDong Auto Holdings' ROCE Trend?

In terms of China MeiDong Auto Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 17% from 30% five years ago. 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 44% 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. Keep in mind 44% is still pretty high, so those risks are still somewhat prevalent.

Our Take On China MeiDong Auto Holdings' ROCE

In summary, China MeiDong Auto Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 464% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a separate note, we've found 2 warning signs for China MeiDong Auto Holdings you'll probably want to know about.

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.