Returns On Capital Signal Tricky Times Ahead For Xin Yuan Enterprises Group (HKG:1748)

There are a few key trends to look for if we want to identify the next multi-bagger. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Xin Yuan Enterprises Group (HKG:1748), it didn't seem to tick all of these boxes.

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 Xin Yuan Enterprises Group is:

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

0.03 = US$4.8m ÷ (US$200m - US$42m) (Based on the trailing twelve months to December 2021).

Thus, Xin Yuan Enterprises Group has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Shipping industry average of 12%.

Check out our latest analysis for Xin Yuan Enterprises Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Xin Yuan Enterprises Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Xin Yuan Enterprises Group, check out these free graphs here.

How Are Returns Trending?

On the surface, the trend of ROCE at Xin Yuan Enterprises Group doesn't inspire confidence. Around five years ago the returns on capital were 9.8%, but since then they've fallen to 3.0%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Xin Yuan Enterprises Group has decreased its current liabilities to 21% 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.

Our Take On Xin Yuan Enterprises Group's ROCE

Bringing it all together, while we're somewhat encouraged by Xin Yuan Enterprises Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 29% over the last three years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know more about Xin Yuan Enterprises Group, we've spotted 2 warning signs, and 1 of them shouldn't be ignored.

While Xin Yuan Enterprises Group 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.