Some Investors May Be Worried About China MeiDong Auto Holdings' (HKG:1268) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. 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.

Return On Capital Employed (ROCE): What Is It?

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 China MeiDong Auto Holdings, this is the formula:

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

0.068 = CN¥689m ÷ (CN¥14b - CN¥4.3b) (Based on the trailing twelve months to June 2023).

Thus, China MeiDong Auto Holdings has an ROCE of 6.8%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 9.9%.

See 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 to see what analysts are forecasting going forward, you should check out our free report for China MeiDong Auto Holdings.

So How Is China MeiDong Auto Holdings' ROCE Trending?

On the surface, the trend of ROCE at China MeiDong Auto Holdings doesn't inspire confidence. Around five years ago the returns on capital were 32%, but since then they've fallen to 6.8%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, China MeiDong Auto Holdings has done well to pay down its current liabilities to 30% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From China MeiDong Auto Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that China MeiDong Auto Holdings is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 2.6% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Like most companies, China MeiDong Auto Holdings does come with some risks, and we've found 3 warning signs that you should be aware of.

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.