Edianyun (HKG:2416) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. In light of that, when we looked at Edianyun (HKG:2416) and its ROCE trend, we weren't exactly thrilled.

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

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 Edianyun:

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

0.059 = CN¥120m ÷ (CN¥3.3b - CN¥1.2b) (Based on the trailing twelve months to June 2024).

Therefore, Edianyun has an ROCE of 5.9%. In absolute terms, that's a low return but it's around the IT industry average of 5.4%.

See our latest analysis for Edianyun

Above you can see how the current ROCE for Edianyun compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Edianyun for free.

The Trend Of ROCE

When we looked at the ROCE trend at Edianyun, we didn't gain much confidence. Around three years ago the returns on capital were 26%, but since then they've fallen to 5.9%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Edianyun has decreased its current liabilities to 38% 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.

In Conclusion...

To conclude, we've found that Edianyun is reinvesting in the business, but returns have been falling. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 82% over the last year. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

On a final note, we found 2 warning signs for Edianyun (1 is a bit concerning) you should be aware of.

While Edianyun isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.